Where Apple turns for growth with iPhone stalling

Where Apple turns for growth with iPhone stalling

The iPhone still accounts for more than two-thirds of Apple's revenue, but there's a growing consensus that the company's future lies elsewhere.

Last month's launch of the new, smaller iPhone SE was so underwhelming that the most surprising feature was the price tag: At $399, it's $150 below the next-cheapest model.

The Twitter hashtag #PeakiPhone made the rounds on Jan. 26, after Apple reported a meager 1 per cent increase in year-over-year iPhone sales. And according to the website 9to5Mac.com, KGI analyst Ming-Chi Kuo has put out a report saying that the iPhone 7, expected for later this year, will trail the iPhone 6S and 6S Plus in terms of shipments.

But for investors focused on profitability, perhaps it's time to stop obsessing over Apple's flagship device.

That's the message from Credit Suisse analyst Kulbinder Garcha. In a note published Monday, Garcha's team wrote that Apple's services business should double its profit contribution to the tech giant by 2020, offering a big reason to buy the stock. His target of $150 represents a 35 per cent increase over Monday's closing price of $111.12.

Garcha told CNBC that the software margins from iTunes and iCloud and the predictable revenue tied to subscriptions for things like Apple Music and an eventual TV service are highly favourable compared to the commoditizing hardware market.

"If you have a services business, it's recurring," Garcha said in an interview Monday on CNBC's "Halftime Report." "This is very good for both margins and free cash flow."

Services revenue climbed 26 per cent to $6.1 billion in the fiscal first quarter. That includes the AppleCare warranty programme, app store sales, music and books.

Growth in the services business also helps Apple diversify its overall portfolio and gives investors a story that doesn't rely so much on hit products.

"Not everything becomes about the iPhone coming out in September and how many do they sell in the December quarter," Garcha said. Apple has actually outperformed the broader market so far this year after a miserable back half of 2015 and beginning of 2016.

The stock has gained 5.6 per cent this year as of Monday's close, topping the S&P 500's 1.1 per cent gain. After briefly handing over title of most valuable company to Alphabet in February, Apple is now worth almost $100 billion more than Google's parent.

And not all investors have lost confidence in the iPhone.

Jeremy Gleeson, manager of the Axa Framlington Global Technology Fund, counts Apple among his three biggest holdings along with Alphabet and Facebook. He told CNBC on Monday that Apple should gain share of the smartphone market with the lower-cost SE device.

"Valuation wise, it's very attractively priced versus many of its peers, and they continue to deliver good consumer experiences," Gleeson said. "They will continue to deliver good returns, maybe not the stellar returns they have in the past, but certainly good returns."

Apple did not immediately respond to a request for comment.

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