Apple’s Fiscal Q4 Earnings Preview: Services Under Pressure

The day is fast approaching: Apple  (AAPL) - Get Free Report reports fiscal Q4 results on Thursday, October 27, after the closing bell – stay tuned for our live blog coverage. So far, we have previewed the event with the following articles:

• The key numbers to track, from revenues to EPS and beyond
• The Mac and how Apple has been lavishly beating the competition
• The iPhone is likely to be the star of the show once again

Today, we talk about the services segment. While this business may have been greatly responsible for Apple’s financial success and expanding stock valuations in the past few years, it could be more of a problem in the short term. Below, I explain why.

Read more from Apple Maven: Apple Q4 Earnings: Countdown Begins, Here Are The Key Numbers

Apple’s Services: boosted by COVID-19

The graph below shows the growth in service revenues over time. The business produced less than $30 billion in revenues in 2017, representing 13% of the company’s top line. Five years later, the segment is on track to spitting out nearly $80 billion, or one-fifth of company sales.

However, notice a pattern above: service revenues had been on a downtrend until the first few months of the pandemic, in 2020. The stay-at-home economy, aided by monetary and fiscal stimuli, provided a boost to the segment. The growth rate surpassed 30% in fiscal Q3 of 2021.

Since then, the business has cooled off. Sure, tough comps play a role, and it will again in fiscal Q4 of 2022. But it is likely that the days of explosive growth in this segment may have been left in the rearview mirror as consumers began spending on outside-the-home experiences again.

App Store and licensing: potential soft spot

During Apple’s most recent earnings call, CFO Luca Maestri provided the following outlook for services in fiscal Q4:

“Specifically related to Services, we expect revenue to grow but decelerate from the June quarter due to macroeconomic factors and foreign exchange.”

Since services growth landed at 12% last quarter, Apple’s management team is effectively guiding for growth that could even dip into the single-digit territory this time – i.e., 9% or less – as a result of softness in consumer spending and a strong dollar.

One potential area of concern is the App Store, which I estimate accounts for about one-third of Apple’s service revenues. Morgan Stanley has recently reported that “[September marked] the slowest App Store growth as far back as we have the data [to 2015]”. The research shop sees App Store revenues declining by 2% in the quarter.

Another important piece of Apple’s services portfolio is licensing. It is believed that Google’s TAC payments to Apple for search and traffic from iOS devices amounted to $3 billion in 2017.

Very little is publicly known about the terms of the agreement between Apple and Alphabet. What has become clear very recently is that online advertising budgets have been taking a hit during these early innings of global economic deceleration.

Whether Apple will have felt the pain through its services segment in fiscal Q4 is a question that I will try to answer in just a few days.

Read more from Apple Maven: Apple’s Fiscal Q4 Earnings Preview: How Will Mac Perform?

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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting the Apple Maven)