Apple's Q1: Meager iPhone Growth Balanced By Strength In Services Segment, China, And Capital Return

Apple Inc. AAPL's fiscal first quarter earnings report consisted of a combination of an earnings beat and a disappointing forward guidance. Digging beyond the headline numbers shows the bull case is slightly stronger than it was heading into the print, according to analysts at Morgan Stanley.

The Analyst

Morgan Stanley's Katy Huberty maintains an Overweight rating on Apple's stock with a price target raised from $200 to $203.

The Thesis

Apple's earnings report showed that its ecosystem and platform remains "healthy" with the device installed base growing 30 percent over the past two years, Huberty said in a note. This implies Apple has gained market smartphone users even if the overall smartphone market has slowed down. In fact, Apple's growth in fiscal 2018 will come more from an increase in the iPhone average selling price (12 percent growth) than unit growth (4 percent).

Apple's Services growth accelerated from 22 percent as of the end of 2016 to 27 percent and is on track to account for more than 30 percent of the company's entire gross profit dollars by 2021 (versus 20 percent in 2017), the analyst said. Apple is also seeing its market share of smartphone users in China rise since the iPhone X launch and revenue growth from the country accelerated from 12 percent in September to 19 percent.

Apple's ending cash balance of $163 billion in net cash coupled with expectations of $44 billion in free cash flow over the next year implies the company can theoretically buy back 25 percent of its outstanding shares, Huberty said. But a more appropriate assumption for Apple's capital return would be 75 percent in buybacks and 25 percent in dividends.

Price Action

Shares of Apple were trading higher by 0.8 percent at $168.30 early Friday morning.

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