Leading up to the iPhone X release and even into Black Friday, analysts painted the big story for Apple stock around the iPhone X, sticking with their story about how unit numbers are the most important thing. They continued to say the iPhone X is the model that will make the story even bigger than it already was, but we could be seeing a sudden shift in the narrative.
A few analysts are starting to shift their focus for Apple stock from the number of iPhones sold to the long-term picture of the company’s massive user base. So are we starting to see the narrative for Apple stock turn from a story about an exciting and trendy brand to one about a legacy brand that’s still churning out strong sales but no longer excites the masses?
Is the iPhone supercycle thesis for Apple stock dead?
All year long, we’ve read report after report from analysts painting a picture of the so-called “supercycle” thesis, in which Apple stock will soar because the company will sell so many iPhone X units that investors will be amazed and impressed. Then this week UBS analyst Steven Milunovich declared the iPhone X cycle as likely “not a ‘supercycle’ but a solid year.”
He based his declaration on the results from his firm’s latest Evidence Lab survey, which found “flattish” buying intentions this year versus last year. He believes unit growth will slow in the U.S. and Europe because fiscal 2017 was strong. He also expects most of the unit growth to come from emerging markets because developed countries generally had a strong fiscal 2017.
As a result of the results from his firm’s latest survey, Milunovich now looks for a 10% increase in iPhone units rather than the 12% growth he was expecting previously.
Is this the new narrative for Apple stock?
The UBS analyst went on to suggest that if the survey is accurate in that unit growth ends up being rather muted in fiscal 2018, the narrative could switch to what he calls “iPhone annuity,” which basically just means squeezing extra money out of iPhone users. According to Milunovich, Apple management has even said they see the iPhone as an annuity because the installed base is growing with a high retention rate.
“As iPhone cyclicality dampens, investor focus will turn to leveraging that base through other products and services,” the analyst predicts. “For example, the vast majority of iPhone users don’t pay for Apple services—we expect new services to be introduced in coming years.”
Where does Apple go next?
Indeed, at some point, there will be little opportunity for unit growth if Apple keeps rolling as it has with the iPhone for the last ten years. At this point, Apple stock will truly stop being a growth stock—unless the company releases a new growth product that takes the place of the iPhone. This is one reason some value investors such as Warren Buffett have begun to see Apple stock in a new light based on the products the company makes rather than on the strong growth it is able to achieve.
Thus, Apple has two main options for keeping investors happy: release a new growth product or find ways to squeeze more dollars out of the users it already has. If Milunovich is correct, then the company will launch some paid services to try to replace the dollar growth it has enjoyed from getting more people to buy iPhones. iCloud is probably just the tip of the iceberg here, but it’s the beginning of a master plan to convince users to pay for something they previously didn’t pay for. Instead of adding a microSD slot to expand storage like Samsung does, make users pay more for models with extra storage or pay monthly for iCloud.
UBS has a Buy rating and $190 price target on Apple stock.
Where else could Apple look for growth?
Milunovich isn’t the only analyst to shift his focus for Apple stock from iPhone units to user base monetization. Nomura Instinet analyst Jeffrey Kvaal also offered a similar sentiment in his note this week, although it wasn’t his main focus. He also suggested some other areas Apple might look for growth. Specifically, he thinks “revenue drivers beyond the X cycle are taking shape.”
Kvaal expects average selling prices to lift revenues for the December quarter, driven by the iPhone X of course. He sees the X as the first generation of Apple’s augmented reality platform and predicts that generation two next year could include two iPhone models with OLED displays measuring 5.8 inches and 6.5 inches, accompanied by one LCD model.
He sees 3D sensing, augmented reality, services, enterprise sales and the Apple Watch as being the main drivers of revenue in fiscal 2019 and between supercycles in the future.
How high is too high for the Apple stock multiple?
Kvaal pegs Apple’s service revenue at 13% of total sales in 2018, a 20% increase, and he believes such an outcome could boost the Apple stock multiple as services become a higher percentage of the revenue mix. Services revenues typically carry higher margins and are often recurring as well, and because of these two things, investors might assign Apple stock a higher multiple as the mix increases.
The Nomura Instinet analyst noted also that the Apple stock multiple has been cyclical since 2010. It expanded leading up to the iPhone 6 three years ago and then again this year ahead of the iPhone X. However, he also notes that historically, the Apple stock multiple has contracted in the following year as iPhone unit growth slowed.
Kvaal has a Buy rating and $185 price target on Apple stock. The stock fell by as much as 0.56% to $173.12 in intraday trading on Tuesday.