I still assign a Buy investment rating to Apple's (NASDAQ:AAPL) shares.
I wrote about AAPL's September product launch event with my previous article published on September 13, 2022. In this latest write-up for the company, I focus on the growth in Apple's paid subscriptions which have exceeded 900 million. I believe that the market will be willing to assign a higher valuation multiple to AAPL, taking into account my forecast and expectations of higher Services revenue contribution driven by growing subscriptions.
Apple revealed at the company's Q4 FY 2022 (YE September 30) earnings call that its paid subscriptions increased by approximately +5% QoQ from in excess of 860 million in the third quarter to over 900 million for the most recent quarter.
The paid subscriptions numbers for AAPL are even more impressive, if one looks at the growth over a longer time frame. Specifically, Apple's paid subscriptions have jumped by more than +100% in the last three years, and the company's latest paid subscriptions represent a +21% YoY increase over the past one year.
There are other key metrics relating to Apple that investors should watch, apart from the paid subscriptions figure.
AAPL disclosed in the company's fiscal 2022 10-K filing that it generated 38% and 62% of its most recent full-year top line from "direct and indirect distribution channels", respectively. In its FY 2022 10-K filing, Apple defines the direct channel as "its retail and online stores and its direct sales force", while it refers to "third-party cellular network carriers, wholesalers, retailers and resellers" (mainly relating to product sales) as the indirect channel.
It is noteworthy that the proportion of Apple's revenue derived from the direct distribution channel was relatively lower at 36% and 34% for FY 2021 and FY 2020, respectively. In my opinion, the increase in revenue contribution from the direct distribution channel for Apple serves as another indicator which shows that AAPL's Services business is expanding.
Another key metric worth noting is the increase in prices for some of Apple's key subscription offerings. An October 24, 2022 Seeking Alpha News article highlighted that AAPL "is raising the prices on its media subscription services" such as Apple Music, Apple TV+ and Apple One "for the first time in the United States."
The expansion of Apple's Services business and subscription services isn't just about volume growth (paid subscriptions increase) alone, as pricing is also another key growth driver. Morgan Stanley (MS) published a research report (not publicly available) titled "Remain OW After A Solid Sept Q" on October 28, 2022 which estimated that AAPL's recent price hikes for selected subscription offerings "could add up to 3 points to Services growth assuming zero churn."
Apple also revealed some important metrics at its most recent quarterly investor briefing, noting that the company saw "double-digit growth in switchers on iPhone" and "another record on our installed base of active devices" in Q4 FY 2022. More consumers switching from Android phones to iPhones and a further expansion of AAPL's installed base are definitely tailwinds for the company's future paid subscriptions and Services revenue growth.
The growth in paid subscriptions, the increase in direct channel revenue, price hikes for subscription offerings, and a larger installed base are all positive signs for Apple's future business forecast.
In my September update for Apple, I emphasized that "a more favorable mix with a bias towards higher-priced or higher-margin products and services" is a key part of the investment thesis for AAPL.
The Services business accounted for 19.8% of Apple's total sales for fiscal 2022, and my forecast is that Services' revenue contribution can rise to 25% or even higher in the next five years.
In the short term, Apple's share price upside might be capped by headwinds relating to production disruption. In the past one month, AAPL's stock price rose by +0.5% as compared to a 5.5% increase for the S&P 500. On November 7, 2022, the company issued an 8-K filing disclosing that " COVID-19 restrictions have temporarily impacted the primary iPhone 14 Pro and iPhone 14 Pro Max assembly facility located in Zhengzhou, China." This has led Wall Street analysts to reduce their FY 2023 financial projections for AAPL.
In the long run, a growing proportion of revenue generated from the Services business and subscription services is the key catalyst that should allow Apple's stock to eventually head higher. Recurring subscription services are seen as generating higher-quality revenue for AAPL as compared to one-off product sales, while a bigger share of higher-margin subscription services will boost Apple's overall profitability. This should put Apple in a good position to command a higher valuation multiple in the long term.
AAPL stock is a Buy based on my analysis. The steady increase in Apple's paid subscriptions is encouraging, and I am of the view that a larger paid subscription base and higher Services revenue will re-rate AAPL's shares.
Asia Value & Moat Stocks is a research service for value investors seeking Asia-listed stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like "Magic Formula" stocks, high-quality businesses, hidden champions and wide moat compounders). Sign up here to get started today!
This article was written by
Those who believe that the pendulum will move in one direction forever or reside at an extreme forever eventually will lose huge sums. Those who understand the pendulum's behavior can benefit enormously. ~ Howard Marks
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.