📱 Apple: Warren's favorite
Services reached 33% of Apple's gross profit in FY22
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Apple (AAPL) just reported its Q4 FY22 earnings (ending in September).
We get to look at the FY22 performance of the biggest company in the world!
Today, we’ll cover the following:
Before we start, let’s discuss how Apple makes money:
Revenue has two main components:
Products (~80% of overall revenue):
📱 iPhone (more than 50% of overall revenue).
⌚️ Wearables, Home and Accessories (~10%).
💻 Mac (~10%).
🖊 iPad (~7%)
Services (~20% of overall revenue) include the App Store, Apple Music, Apple Pay, AppleCare, Apple TV+, Apple Arcade, Apple Fitness+, iCloud+, and more. Note that they also include that juicy annual payment from Google to remain the default search engine on Apple devices.
Cost of revenue includes the cost of creating and delivering these products and services.
Margins: Products have a relatively low margin profile (36% gross margin in FY22). On the other hand, related services generate twice as much (72% gross margin in FY22). Why? Services can scale with limited marginal costs. Meanwhile, hardware always involves manufacturing costs.
1. Apple FY22
Apple has a lot of seasonality to its hardware cycle (with big releases in the Fall), so let’s focus on the full year FY22 to review the business performance and trends.
Here is a bird’s-eye view of the income statement.
Data source: Q4 FY22 results.
Revenue grew +8% Y/Y to $394 billion.
Products grew +6% Y/Y to $316B (80% of revenue).
Services grew +14% Y/Y to $78B (20% of revenue).
Gross margin was 42% (+2pp Y/Y).
Operating margin was 30% (+1pp Y/Y).
EPS (earnings per share) grew +9% Y/Y to $6.11.
Operating cash flow was $122 billion (31% margin, +2pp Y/Y).
Cash, cash equivalent, and marketable securities: $169 billion.
Total debt: $120 billion.
Q1 FY23 Guidance:
Apple hasn’t provided guidance since 2020, citing uncertainty.
CFO Luca Maestri provided the following directional insights:
Overall revenue growth would decelerate, with a 10pp fx headwind expected.
Mac sales would decline Y/Y due to a tough comparison with the launch of the Macbook Pro with M1 last year.
Services would grow, but not as fast (due to macro headwinds).
So what to make of all this?
Apple had decent results in an otherwise terrible week for tech: It’s impossible to look at Apple’s performance in a vacuum. The company was slightly ahead of expectations despite a challenging macroeconomic backdrop.
The strong dollar adversely impacted the recent performance, with over 600 basis points of negative foreign exchange impact in Q4 FY22. For example, in Q4 FY22, Services only grew +5% Y/Y. But it grew +11% Y/Y in constant currency (a better representation of the long-term growth profile of the segment).
Services now account for 33% of Apple’s gross profit. It was the fastest-growing segment in FY22 (+14% Y/Y). It’s critical to note that the segment lapped a strong FY21 (Services grew +26% Y/Y last year). The Apple-as-a-Service thesis isn’t new, but it continues to materialize. Services are slowly making a larger share of the revenue, resulting in a gradual improvement in the margin profile of the business. As a result, most analysts expect earnings growth to outpace revenue growth in the coming years.
Is the business sustainable?
Apple generated $122 billion in cash from its operations. Analysts expect operating cash flow to increase steadily in the coming years (in the high single-digit).
The company is returning most of its cash to shareholders. To illustrate, Apple repurchased $89 billion worth of its AAPL stock in FY22. That’s why the EPS (earnings per share) grew faster than the net income.
For some perspective on the tremendous execution under Tim Cook, the chart below shows Apple’s annual net income since 2005.
2. Recent business highlights.
iPhone sales were slightly lighter than expected in Q4, partially due to the fx headwind. iPhone revenue grew only +7% Y/Y in FY22, but it was on top of an FY21 that saw iPhone revenue grow +39% Y/Y. Notably, several emerging markets doubled Y/Y in Q4, such as Vietnam, Indonesia, and Thailand.
Mac was the fastest-growing product category in the past year (+14% Y/Y). There were many factors at play, such as the successful transition to Apple Silicon (M1 and M2 chips replacing the Intel processors), the longer battery life, and the continuity of the Apple ecosystem for iPhone owners. Q4 FY22 benefited from the launch of the new Macbook Air and Macbook Pro powered by the M2 chip. Additionally, there was pent-up demand from the previous quarter that was supply constrained.
Wearable, Home and Accessories exceeded Wall Street’s expectations in Q4 FY22. The new Apple Watch Ultra (higher selling price) boosted this segment and is supply constrained. In addition, the new AirPods Pro (H2 chip) received excellent reviews.
iPad revenue was slightly down, partially due to the fx headwind. Half of the customers who purchased iPads during Q4 were new to the product. So the soft numbers are primarily due to longer upgrade cycles.
Services: The company reached 900 million paying subscribers (+21% Y/Y, doubling in the past three years). Apple raised its price in the US for Apple Music (due to increasing licensing costs) and Apple TV+ (end of the introductory price).
3. Key quotes from the earnings call
CEO Tim Cook explained:
“We reached another record on our installed base of active devices, thanks to a quarterly record of upgraders and double-digit growth in switchers on iPhone.”
Given Apple’s 15%-20% global market share, switchers are a critical part of the growth story.
Apple’s installed base of active devices reached a new record. How many devices exactly? Management didn’t say. The last figure shared publicly was 1.8 billion active devices nine months ago. We’ll probably hear an update when they cross the 2 billion mark.
About iPhone demand, he added:
“Since the beginning, we've been constrained on the 14 Pro and the 14 Pro Max and we continue to be constrained today. And so we're working very hard to fulfill the demand.”
It’s a fascinating nugget considering the chatter pre-earnings suggesting that demand was weak for new iPhones. The high demand for the Pro models could be the reason for the softer performance of the regular models. It’s great news for Apple because it should increase the average selling price. According to Reuters, the share of the more expensive Pro model has increased to 60% of the total output and could rise to 65% in the future.
CFO Luca Maestri commented on the iPhone installed base:
“Thanks to our strong iPhone lineup, we set a quarterly record for upgraders and grew switchers double digits. This level of sales performance, along with unmatched customer loyalty, drove the active installed base of iPhones to a new all-time high across all geographic segments. And the latest survey of US consumers from 451 Research indicates iPhone customer satisfaction of 98%.”
As expected, gaming was one of the lowlights for Services revenue:
“Digital advertising and gaming are areas where we've seen some softness. Throughout the quarter, we continued to observe several trends that reflect the strength of our ecosystem and our long-term opportunity in the category.”
The weakness in mobile gaming is something I noted in my review of Google’s quarter. Based on the data from Sensor Tower, Android saw more softness than iOS. Overall, I wouldn’t read too much into it. The Apple App Store and Google Play were lapping huge quarters in 2021.
“We now have more than 900 million paid subscriptions across the Services on our platform, up more than 155 million during the last 12 months alone and double what we had just three years ago.”
Of course, the growth in paid subscribers is bullish for the long-term potential of the Services segment.
On cost-cutting, Tim Cook explained to CNBC:
“We are hiring deliberately. And so we’ve slowed the pace of hiring.”
4. What to watch looking forward
Market share and installed base expansion:
According to Market Data Forecast, the smartphone industry could rise at a 7% CAGR until 2027. Historically, Apple has outpaced the industry.
To appreciate Apple’s recent performance, Strategy Analytics shows quarterly smartphone shipments in the chart below. While Apple grew iPhone shipments by 7% Y/Y in the last quarter, all other leading vendors declined. So it makes Apple’s performance look even more impressive.
Services, services, services.
With this week’s release of iOS 16.1, Apple Fitness+ is now available to anyone with an iPhone (it was previously limited to Apple Watch owners). Considering the installed base, it could be a big deal, potentially overlapping with Apple Music.
Apple doesn’t disclose its advertising revenue. Tim Cook said it was “not large” during the earnings call. But maybe not for long. Earlier this week, the company added more ad placements in the App Store (in the main Today tab and the “You Might Also Like” section).
Apple is rumored to be working on increasing its advertising business aggressively in the coming years. For example, it could serve ads in Apple Maps as early as 2023.
The untapped potential of advertising remains gigantic. If Apple can take a page from Google and Amazon’s playbook, it could unlock tremendous value for shareholders in a high-margin category. However, the company will have to walk this line carefully, given its focus on consumer privacy.
As best put by Benedict Evans:
“Apple has been quietly floating a TV ad product as well. As ever, if Apple does it, it’s private, and if anyone else does it, it violates your human rights.”
That’s it for today!
Stay healthy and invest on!
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