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Don't Underestimate Apple's iPhone Business

Daniel Sparks, The Motley Fool

Apple's (NASDAQ: AAPL) iPhone business has a bad reputation recently. The segment's status as a key driver for the tech giant's business took a hit on Jan. 2 when CEO Tim Cook said the company would miss the midpoint of its fiscal first-quarter revenue guidance by a whopping $7 billion -- a shortfall Cook said was due to weakness in iPhone sales. Since then, there's been ongoing speculation from analysts that iPhone sales have continued to struggle in China.

But in the process of focusing on what's wrong with Apple's iPhone business, are investors failing to fully appreciate the massive, profitable segment's value even if iPhone sales fail to grow in the coming years? After all, Apple stock's conservative valuation requires very little underlying business growth to justify its price tag.

Apple marketing chief Phil Schiller reveals the iPhone XR

Image source: Apple.

Apple's iPhone business: an annuity-like income stream?

On Thursday, Cowen analyst Krish Sankar expressed optimism (via CNBC) for Apple's iPhone segment -- a rare take these days. The tech company's loyal iPhone customer base, which Sankar says is at "900 million strong," encapsulates a user base that Apple "can offer a growing ecosystem of devices such as wearables and new content subscriptions and service offerings."

In addition, Sankar said that of Apple's active base of 900 million iPhone users, some customers have devices that are nearing five years old. Sankar believes, therefore, that "iPhone shipments are running near replacement demand."

If Apple can continue generating similar levels of annual sales and profits from its iPhone segment in the coming years, the tech giant's other growth drivers -- particularly services and other products -- could help the tech giant see continued growth in consolidated revenue and profits over the long haul. Though these two segments combined account for just 22% of Apple's trailing-12-month revenue, they are growing rapidly. Trailing-12-month services revenue increased 27% year over year, and other products revenue was up 34% over the same time frame.

Are China concerns overblown?

China was the crux of Apple's iPhone demand problem in its fiscal first quarter. "Lower than anticipated iPhone revenue, primarily in Greater China," explained Cook in his Jan. 2 letter to shareholders, "accounts for all of our revenue shortfall to our guidance and for much more than our entire year-over-year revenue decline."

But the media seems to have glossed over Cook's confidence that China will remain a key driver of Apple's business over the long haul -- and his confidence wasn't based on fluff, but rather on concrete trends.

"Despite these challenges, we believe that our business in China has a bright future," Cook explained in the Jan. 2 letter.

He continued:

The iOS developer community in China is among the most innovative, creative and vibrant in the world. Our products enjoy a strong following among customers, with a very high level of engagement and satisfaction. Our results in China include a new record for Services revenue, and our installed base of devices grew over the last year.

As it turns out, there's another analyst on the Street expressing optimism for Apple's iPhone business on Thursday: Influential Morgan Stanley analyst Katy Huberty. She believes that Apple's price cuts on its iPhone XR helped the company gain market share in China in both January and February on a year-over-year basis. In addition, she believes the company's recent price cuts to its flagship iPhone XS and XS Max could help the company see a further increase in demand this month.

Sure, investors shouldn't be betting on iPhone revenue to return to year-over-year growth yet. After all, iPhone revenue was down sharply in the company's fiscal first quarter, falling from $61.1 billion in the year-ago period to $52 billion. But investors shouldn't count out the segment as an important asset for Apple in the coming years.

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Daniel Sparks has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.