- Wall Street analysts are far too pessimistic in their estimates for Apple‘s hardware sales over the coming years, Bank of America Merrill Lynch research analysts wrote in a note to clients.
- The firm says the rise of 5G will drive “significant” hardware and iPhone unit revenue growth in 2021.
- Shares of Apple have climbed nearly 18% this year, though they’re still trading 26% below their record high hit in October.
- Follow Apple’s stock price here on Markets Insider.
Investors were rattled when Apple said late last year that it would no longer report iPhone unit sales. There was also the company’s warning last month about its weak fourth-quarter results, which was largely due to issues surrounding the iPhone.
Both instances sent the stock plunging and sparked renewed concern over a slowdown for the flagship product. Meanwhile, the services segment has thrived, with revenue jumping 19% in one year, according to Apple’s latest earnings report.
In a new report from Bank of America Merrill Lynch examining the state of both hardware and services, research analysts contended that analysts were generally too pessimistic in their forecasts for how hardware product sales would fare relative to services in the coming years.
Specifically, Wall Street thinks hardware sales will decline meaningfully through 2021 and badly lag services-driven revenue growth. But the firm says that’s too negative an outlook.
“In our opinion, consensus is incorrectly baking in a relatively higher contribution from Services (to total company GP dollars) and is arguing for a higher multiple on the stock,” New York-based analysts led by Wamsi Mohan said in a report distributed Tuesday.
He continued: “While margins are indeed high in Services, the materiality of Services to total company profit dollars is still a work in progress, in our opinion, and for the next several years, Hardware remains the dominant driver of earnings.”
More granularly, Bank of America outlined the scenario it believes the majority of analysts are building into their outlook: hardware and accessories revenue declining at a 2% compound annual growth rate over the three-year period from 2018 to 2021. That also includes Apple’s gross margin shrinking by 100 basis points each year, and services revenue growing at a 3% CAGR in that time.
“We see that even if Services margins grow to 70%, Services still only contributes ~42% of total company gross profit dollars in F21 (still much less than 50%). That is Hardware remains the major contributor of gross profit dollars for Apple,” the analysts said.
“In our opinion, to assume continued decline in Hardware revenues is too pessimistic.”
After all, services — a group of business segments including the App Store, licensing, iCloud, and AppleCare — still make up a small chunk of Apple’s overall sales and profit.
Services accounted for $39.7 billion in revenue and $23.7 billion of gross profit in 2018, or 23% of Apple’s total gross profit. Meanwhile, hardware and accessories accounted for $226 billion of revenue and $78 billion of gross profit in the same time — 77% of total gross profit.
In a model closer to what Bank of America estimates, the firm said it’s more likely that Apple’s hardware and accessories revenue grow at 5% CAGR from 2018 to 2021, with margins unchanged, and services revenue growing at a three-year CAGR of 20%. Additionally, the firm said it saw Apple benefitting from the launch of a 5G iPhone, expected next year, which should drive “significant” year-over-year iPhone unit and hardware revenue growth in 2021.
To be sure, the firm isn’t alone in its view that services isn’t the explosive-growth segment some investors think it will prove to be.
The widely followed Bernstein analyst Toni Sacconaghi, who carries a “market perform” rating on Apple, wrote in a note to clients on Tuesday that he expected services growth to slow this year. Taking his view a step further, he said he didn’t think Apple’s different components could always be compared equally.
“On the bull side, investors oftentimes espouse that Apple should be valued on a sum of the parts (SotP) basis, breaking out the profit contribution between slow-growing hardware and fast-growing, higher margin Services,” he said. “We are skeptical of this assertion, as we believe SotP is generally only valid when valuing 2+ truly independent 21 businesses that could theoretically be split apart.”
More broadly, the Bank of America analysts carry a “neutral” investment rating on Apple shares because of a “lack of near-term catalysts” for the stock and continued weakness in iPhone sales — both of which the firm believes are balanced out by a relatively attractive valuation and the company’s hefty net cash a share.
Shares of Apple have climbed nearly 18% this year, though they’re still trading 27% below their record high hit last October.
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