To Apple warehouse (AAPL) – Get Apple Inc. report Expectations have gradually softened since late September due to optimism about the iPhone 14 cycle. The recent data point could spell trouble for the company’s financial performance and the stock, in my opinion.
Today I’m going to talk about the App Store, one of Apple’s main product or service subcategories next to the iPhone. Could there be signs of a slowdown in consumer spending yet to show up in Apple’s financial reports?
(Read more from Apple Maven: Apple stock: Stakes are sky high ahead of Q3 earnings)
The App Store is cooling down
For context, the App Store is Apple’s ecosystem of applications for iPhone, iPad, and other Apple products.
While the Cupertino-based company doesn’t disclose any financial information about it, it’s common knowledge that the App Store is one of the most important parts of its service portfolio. I estimate that App Store revenue accounts for about a third of service segment revenue.
Morgan Stanley recently released a report on App Store sales for September and the fourth fiscal quarter. According to analyst Erik Woodring, based on data from Sensor Tower:
“[September] marks the slowest App Store growth as far as we have the data [to 2015]”
He estimates sales for the September quarter were down 2% year over year. With that, the analyst sees services revenue growing just 8% in the fiscal fourth quarter, three percentage points below consensus.
The impact of slowing App Store growth
I believe Apple stock has been able to achieve significantly higher valuation multiples over the past 10 years due to three main factors (see chart below):
- Apple bounced back quickly in the battle for global smartphone dominance against Samsung and other Asian vendors, especially after the launch of the iPhone 7.
- CEO Tim Cook went all-in on share buybacks starting in 2012.
- The company began changing its business model to monetize its growing installed base, away from lower-margin products and toward higher-margin services.
It’s hard to say which of the above three factors was the most important that sent AAPL’s P/E ratio skyrocketing from 10x in 2013 to 40x during the pandemic and to about 24x today. But I suspect services — and the App Store in this segment — have played a crucial role.
Going back to late 2016, I remember the early conversations about what the services segment could become for Apple. In an article I wrote about Seeking Alpha, now six years old, I said that “Services [would] determine the success of Apple”. And they did, as Apple roughly doubled segment sales between 2015 and 2018 and from there through 2022.
Granted, comps are particularly tough in the fourth quarter of fiscal 2022. Around this time last year, Apple managed to grow service revenue by an impressive 26%. But if Morgan Stanley is right about growth slipping into the single digits (ie, less than 10%), investors might feel a little uneasy.
A decline in sales in the App Store can not only affect a single sub-segment. This could be one of the first signs of weaker consumer spending on the back of the toxic cocktail of high inflation and rising interest rates that many believe will lead to a 2023 recession.
As an AAPL investor (or pretend to be one), which of the following worries you most about the stock, if any?
Land a top job in equity research with Peak Frameworks
Stock research is a great career path that combines in-depth industry analysis and financial modeling while exposing you to the strategic frameworks of many different types of investors in the stock market.
Many students have used Peak Frameworks’ stock research course to enter the industry after school or to transition into the field from a career outside of finance. The lead trainer has experience at Goldman Sachs and JP Morgan and has been involved in the recruitment process at both banks, giving you a comprehensive overview of the skills you need to prepare for an interview.
To learn more, click this link and use code APPLEMAVEN10 for 10% from the course.
(Disclaimers: This is not investment advice. The author may own one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence the editorial content. Thank you for supporting the Apple Maven.)