The Street continues to be laser focused on the demand trajectory for iPhones into 2019 with the trifecta of next generation iPhones on the horizon and the Street modeling iPhone shipments of roughly 220 million units, which could ultimately prove to be conservative in our opinion given the underlying demand drivers. We believe 350 million iPhones are in the “window of opportunity” to upgrade over the next 12 to 18 months with Apple needing to capture a majority of these units as part of this upgrade cycle to make a clearly successful iPhone product cycle in 2019 and lay the groundwork for future services/software growth and steady iPhone demand over the coming years. With positively trending ASPs heading into this 2019 product cycle, we believe many of the growth fears on the Street have been alleviated around Apple in the near-term, however this upcoming product cycle remains a linchpin for Cook & Co. to lay the groundwork for “steady” iPhone growth for the next few years. We expect three new iPhone releases (5.8 inch to 6.5 inch OLED Plus designs with a lower priced LCD model) staggered over the next 2-4 months to hit the market that will help capture the underlying demand/upgrades among customers that have decided to bypass the 8/8+/X cycle this past time around, with price points and features that catalyze fence sitting iPhone customers onto their next smartphone during the course of FY19 with Chinese consumers front and center. With September Street numbers and FY19 set up well heading into a potentially robust iPhone product cycle along with a massive capital return strategy as another tailwind, we continue to believe Apple shares are compelling over the coming year despite the recent run. In particular we continue to believe the “high octane fuel” from the services business which is on a trajectory to be a $50 billion annual revenue stream by 2020 speaks to the stepped-up monetization of Apple’s unparalleled installed base that is front and center for Cupertino (and its investors) over the coming years. We maintain our Highly Attractive rating while raising our price target from $215 to $245 to reflect our increased confidence in the FY19 growth story for Apple.
Looking out into FY19; China consumer demand a key driver. The massive uptick in ASPs that Apple has experienced on the heels of a modestly successful iPhone X launch, a services business which we forecast is on a trajectory to be a $50 billion annual revenue stream by FY20, and an unparalleled consumer franchise which now has 1.3 billion active devices worldwide speaks to the potential tailwinds that Cook & Co. has for the foreseeable future in our opinion as it further penetrates its massive installed base. The main swing factor in our opinion looking ahead is China (was up 19% year over year in June/FY3Q) as we estimate over a 100 million iPhone installed base in this key region, with over half of these consumers due for an upgrade during the course of FY19. In particular, we estimate between 60 million and 70 million Chinese iPhones will be in the “upgrade window” over the coming year with iPhone’s next generation trifecta of smartphones as a major potential product catalyst in the all important Chinese market, which could see a renaissance of growth on the horizon for Apple despite lingering worries around the overall China market given current tariff/trade tensions. To this point, as China trade worries appear to now be in negotiation mode the biggest lingering worry for the Street is around any possible supply chain disruption that could cause a speed bump for Apple/iPhones heading into this major product cycle. We believe this issue so far is contained however will be a key dynamic we will be keeping a very close eye on over the next 6-8 weeks as the iPhone enters its pivotal launch phase.
Upgrade cycle could unleash the next leg of growth on Services. We believe Apple’s new products should drive high margin services revenue growth and continue to drive the company’s unique software/services ecosystem across technology. While Apple’s product pipeline and demand trajectory around Macs and iPads should sustain relatively stable revenue for FY19, clearly the biggest area of growth and margin improvement is around the company’s growing services business as evidenced again in the recently reported June quarter. With iCloud, Apple Pay, Apple Music, and other digital downloads driving this vast ecosystem, we believe this segment could top $50 billion of revenues by FY20 as the growing iPhone installed base further drives this software/services business with a potential streaming service (and future acquisitions around content, studios) as a wild card. In our opinion, as the services business continues to significantly ramp over the coming years this will be a key variable to Apple’s stock ultimately getting re-rated over time with the Street giving more credit to this incremental growth and margin driver for Cupertino going forward.