<p>In Apple’s 2Q18 results, services segment is the star performer with strong 31% y-o-y growth. It could replace iPhone as the new apple polisher to CEO Tim Cook.</p><p> </p><p><b><span style="text-decoration: underline;">Strong growth in the services segment </span></b></p><p>Revenue from the services segment grew 31% y-o-y and now represented 15% of total company sales.</p><p>iPhone still make up the bulk of Apple’s sales with close to 62%. But, it only grew 3% this quarter.</p><p>In the services segment, sales from iTunes, Apple Music, Apple Pay and the App store are the main contributors. So far, only less than half of Apple’s user are paid users. This represent an enormous opportunity for Apple to grow this segment. For instance, Apple is looking to expand its 40 million user base in Apple Music by lowering its pricing for students.</p><p>On the other hand, iPhone sales were meagre at 3%. iPhone X did not perform well as it was priced at the high end price of $999. Apple is diversifying its iPhones to multiple price points from low to high end. However, it could be facing tough completion form cheaper Chinese and Korean smartphones as ASP for iPhones have come off 8% to $728.</p><p>Apple expect the strong growth in services segment to offset any weakness in future iPhone sales. A higher services revenue mix is also positive for margins and have helped Apple to maintain its gross margin at 38.3%.</p><p> </p><p><b><span style="text-decoration: underline;">High inventory</span></b></p><p>Apple is using its huge cash pile to hold higher inventory. The inventory jumped more than 70% q-o-q to $7.6bn. The bulk of inventory increase is due to components rather than unsold iPhones. This could be a strategic intent to secure components in tight supply such as memory and OLED panels. With higher inventory, it helps Apple to protect its margin from any price hike in component prices. However, this could impact Apple negatively should these component prices correct and result in inventory write-offs.</p><p> </p><p><b><span style="text-decoration: underline;">$100bn buyback</span></b></p><p>Apple announced a $100bn share buyback. Dividend was also raised 16% to $0.73 per quarter, equivalent to 1.7% dividend yield. Apple is attractively valued at 6.5% earnings yield. Thus, it makes more economic sense for Apple to buy back more shares compared to paying out the cash as dividends. The $200bn share purchase is almost 11.5% of its market cap. There is no end date to the share buyback program and it would likely be used to support Apple’s share price on any dips.</p><p>Apple delivered a solid 2Q18 results with EPS at $2.73, beating expectations of $2.69. The share price reacted positively, rising more than 4% on the day of result announcement. The market appreciates the generous buyback as well as the robust growth in the services segment.</p><p>To combat the slowdown in iPhone, CEO Tim Cook has focused on selling an array of services via its large user base. He will surely take delight at the strong growth in services segment.</p><p>The services segment has turned out to be such an Apple polisher!</p><p> </p><p><b>Edmund Chan, CFA</b></p>