Bank of America is bullish on Apple: Service business becomes the "second curve," gross margin enters a long-term upward channel

According to the Zhitong Finance APP, Bank of America has released a research report, reiterating its "Buy" rating on Apple (AAPL.US) based on stable cash flow, resilient profitability, and a strong capital return plan, with a target price of $250. Bank of America pointed out that compared to the iPhone business, Apple's services business will contribute more to gross profit; the level of gross margin increase is long-term rather than cyclical, with gross margins expected to continue rising to around 50% over time.

For many years, the iPhone has been the main contributor to Apple's annual gross profit. However, this situation is undergoing a significant shift as the growth rate of the services business is faster and has a higher gross profit margin. Therefore, Bank of America estimates that in fiscal year 2025, the services business will surpass the iPhone, contributing 42% of annual gross profit, while the iPhone's contribution will be 41%. Bank of America expects this gap to widen to 44%/39% by fiscal year 2027. The high-margin services business has been (and is expected to continue to be) the main driver of year-on-year growth in annual gross profit.

Although iPhone sales are somewhat cyclical and affected by product cycles, Bank of America believes that the revenue from the services business is long-term, with an expected annual year-on-year growth rate in the low double digits (12% year-on-year growth rate, at least for the next few years). Currently, the company's stock price is valued at 29.5 times Wall Street's earnings forecast for fiscal year 2026. In contrast, the long-term valuation range is between 10 and 33.5 times, with a median of 21 times. Bank of America believes that the higher the proportion of gross profit from more stable and sustainable revenue sources (services business), the higher the corresponding price-to-earnings ratio should be.

Over time, gross margins are expected to continue rising to around 50%. Although concerns about tariffs (which have a negative impact of -100 to -200 basis points on gross margins) and the potential adverse ruling by the U.S. Department of Justice in the Google (GOOGL.US) antitrust case (about -300 basis points) still exist, the underlying business continues to drive gross margin increases (Figure 4), as product mix, vertical integration, and pricing remain potential positive factors By the end of the quarter, foreign exchange will also have a favorable impact on the gross profit margin