Morgan Stanley: Buy Apple shares on the ‘emerging power’ of its services

  • Morgan Stanley believes investors are underestimating the potential of Apple's services businesses.
  • The firm's analyst predicts the company's services segment will represent 67 percent of Apple's sale growth in the next five years.
Customers check the new iPhone X in London.
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Customers check the new iPhone X in London.

The vast majority of Apple's future revenue growth will be generated by its services, according to Morgan Stanley.

The firm reiterated its overweight rating for Apple shares, saying investors are underestimating the strength of its App store business.

"We counter the [Apple] bears, arguing that App Store growth is sustainable and take rates are defensible. As a result, we believe Services margins have room to expand and the market is undervaluing the Services business," analyst Katy Huberty said in a note to clients entitled "The Emerging Power of Apple Services, Part 2: The App Store" Wednesday.

Huberty raised her price target to $214 from $200 for Apple shares, representing 14 percent upside from Wednesday's close.

The analyst noted how Apple's services revenue growth improved to 31 percent year-over-year from 18 percent year-over-year during the company's last five quarters, while iPhone unit sales rose 1 percent year-over-year on average in the same time period.

She predicts the company's services business will represent 67 percent of Apple's sale growth in the next five years, led by the App Store.

"We believe the App Store has significant growth runway ahead," she said. "We believe that Apple is a structurally different company today than it was just five years ago, with a larger (and more accessible) cash balance and a Services business … As a result, we believe that the Services business is being undervalued by investors that use hardware-based P/E or EV/EBITDA multiple valuation to derive their price targets."