An unforgettable year is coming to an end Apple (AAPL 2.38%) Investors faced the broader sell-off in stock markets despite the company’s robust performance amid a soft smartphone market. But 2023 could turn out to be a much better year for the tech giant, as one of its key companies is likely to step on the gas.
We know Apple makes most of its revenue from selling products like the iPhone, iPad, MacBooks, and other devices, but its services business pays big dividends for the company. For fiscal 2022 (ended September 24, 2022), Apple reported $78 billion in services revenue. The segment’s revenue rose 14% year over year and accounted for nearly 20% of the company’s top line.
Apple is expected to continue the tremendous growth of its services business in 2023. Let’s see why that might be the case and how the segment’s growth might contribute to the company’s bottom line.
The services business moves the needle significantly for Apple
Apple had a massive installed base of 1.8 billion active devices at the end of the first quarter of fiscal 2022. Though the company hasn’t updated that number recently, CEO Tim Cook noted on the October earnings call that Apple had set “another record in our installed base of active devices, thanks to a quarterly record of upgraders and double-digit growth in iPhone adoption.”
Given the healthy demand for iPhones and other devices, it will come as no surprise then that the company sits on an installed base of 2 billion active devices. A larger installed base means Apple can sell its services to more users. This explains why the company’s service revenue has grown faster than product revenue.
In fiscal 2022, Apple’s product sales grew just 6% year over year. But increasing adoption of the company’s broad-based services (apps, music, games, TV, cloud, and others) allowed the company to end the fiscal year with revenue growth of 7.7% year over year. Additionally, Apple reported adjusted earnings per share growth of 9% year over year to $6.11 per share, beating revenue growth thanks to the higher-margin profile of its services business.
More specifically, Apple’s services business delivered a gross margin of 70.5% last quarter. That’s more than double its product gross margin of 34.6% and significantly higher than Apple’s overall gross margin of 42.3% last quarter. So the growing influence of Apple’s services business should translate to solid earnings in 2023 and beyond.
The good news is that Apple’s installed base of active devices could continue to grow at a nice pace in 2023, and that should bode well for its services business.
Why the service business could continue to grow in 2023
IDC estimates that 233.5 million iPhones could ship in 2023, a slight increase from this year’s estimated production target of 220 million units. This also indicates that the installed device base will increase again next year.
However, a new product from Apple could give its installed base a significant boost in 2023 and beyond. Supply chain gossip suggests Apple could launch an augmented reality/virtual reality (AR/VR) headset in 2023. The tech giant is rumored to be making 500,000 units of its mixed reality headset in the new year, with each unit expected to cost around $2,000.
Assuming Apple can sell all of these rumored headsets, it could generate $1 billion in sales from a new product line next year. But the bigger game for the company would still be the services business. The company is reportedly working on delivering 3D content through its headsets, according to Bloomberg, with a job listing suggesting it may be developing a virtual environment similar to the Metaverse.
So a mixed reality headset could add another dimension to Apple’s services business. The device will help the company mark its presence in a market that is set to resonate well in the long run. A third-party estimate projects that the mixed reality headset market could generate $19.5 billion in revenue by 2026, compared to an estimated $5.6 billion this year. The growth in sales of mixed reality hardware should open the door for companies like Apple to sell more services over the next year.
All of this suggests that Apple’s services business is poised for long-term growth. It won’t be surprising if this segment hits $100 billion in revenue per year in 2023 MorganStanley estimate. That could help Apple beat Wall Street expectations in the new year and send its shares higher, which is why investors might want to take advantage of the 25% drop this tech stock has seen in 2022 and buy it before she breaks out.
Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.