Morgan Stanley Finds Flavor In Apple's Services, Raises PT

Analysts think they’ve found Apple Inc. AAPL’s sweet spot, and in their models, it makes each bite a little more valuable.

The Rating

Morgan Stanley analyst Katy Huberty maintained an Overweight rating on Apple and raised the price target from $200 to $214.

The Thesis

Huberty considers Apple a “structurally different company” than it was even five years ago, with more accessible cash and a bigger Services business. Morgan Stanley now approaches Apple's valuation with a “sum of the parts” model that distinguishes hardware from services, the analyst said in a note. 

“We believe Services margins have room to expand and the market is undervaluing the Services business,” Huberty said. 

Annual revenue growth in Services has accelerated from 18 percent to 31 percent in the last five quarters against 1-percent average iPhone unit growth. As iPhone replacement cycles draw out, Huberty expects Services to account for two-thirds of Apple revenue through 2023.

The App Store is seen to be the largest driver within that category, accounting for an estimated 40 percent of Services revenue, and Morgan Stanley suspects Apple can sustain the App Store’s critical growth and defend its take rates.

Huberty estimates the App Store generated about $12 billion in revenue last year, up 29 percent year-over-year. Considering its diverse growth contributors in both content and geography, she forecast 26-percent compound annual revenue growth over the next three years.

In the same period, the high-margin App segment is projected by Morgan Stanley to offset faster growth in low-margin businesses and drive a 500-basis point expansion in Apple's Services margin. The App Store will represent 45 percent of Services operating profit growth through 2023, Huberty said. 

Price Action

Apple shares were down 0.4 percent at $187.60 at the time of publication Thursday. 

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Photo courtesy of Apple.