In a research note to investors, Morgan Stanley analyst Katy Huberty raised her price target for Apple (AAPL) to $214 as she believes App Store growth is sustainable and take rates are defensible. Further, Huberty argued that Services margins have room to expand as the market undervalues the tech giant’s Services business. ‘EMERGING POWER’ OF SERVICES: Morgan Stanley’s Huberty raised her price target for Apple to $214 from $200, while reiterating an Overweight rating on the shares. The analyst told investors that the iPhone maker’s App Store growth is sustainable and take rates are defensible. Furthermore, Huberty believes Services margins have room to expand and the market is undervaluing the Services business, which is “fast becoming” Apple’s primary growth driver. As device replacement cycles extend and device installed base growth slows to single digits, Services will pick up the “growth baton” and account for about 67% of Apple revenue growth over the next five years, she contended. While the analyst acknowledged that iPhone data points remain relevant to the Apple thesis, she believes investors should focus on understanding the drivers and growth trajectory of the Services business. Huberty highlighted that some investors argue that the fastest growing but lowest margin businesses within Apple Services – Apple Music, iCloud and Apple Pay – will drive negative mix shift away from higher margin, more established businesses like the App Store, such that Services margins are close to peak levels. However, Huberty disagrees, saying that the App Store is growing off a much larger revenue base, at $12B, and therefore contributes the largest portion of incremental growth going forward. With App Store generating the second highest operating margin within Services, she forecasts Services margins expanding 500bps through 2021, with the App Store accounting for 45% of Services operating profit growth over the next five years. Overall, Huberty thinks Apple is a “structurally different” company today than it was just five years ago, with a larger cash balance and a Services business that accounts for about 15% of revenue and 22% of gross profit dollars this year. By 2022, Services will account for 27% of Apple revenue and just under 40% of gross profit dollars, she added. PRICE ACTION: In morning trading, shares of Apple have slipped about 0.6% to $187.30.
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