Apple reported Dec-18 results essentially in-line with the company’s January 2nd pre-announcement. While revenue was down about 5% y/y, EPS was up 8% to a record high. Bottom line: no company can escape macroeconomic conditions, but Apple is successfully navigating the headwinds. Despite a troubled quarter for iPhone sales, mostly in China, Apple’s ecosystem is stronger than ever, and the company is positioned to return to sustainable mid-to-high-single-digit revenue growth in Dec-19 after what will likely be a 5% decline in FY19. Additional takeaways:

• Shares of AAPL are trading up 5% after-hours based on better than expected guidance. Investors had been bracing for March quarter guidance meaningfully below consensus to avoid missing two consecutive quarters. Our view is that Apple effectively guided in-line with the Street. Typically, the company reports revenue at the high end of their revenue guidance range ($55-$59B), implying $59B in the March quarter.
• Apple’s expanding ecosystem was a clear theme throughout the earning call, evidenced by two new data points:
  1. There are now over 900M active iPhones, up 8.3% y/y. This metric is rarely updated, and we had previously estimated the active iPhone base would exit 2018 at 821M.
  2. The total installed base of Apple devices now stands at 1.4B. That number grew by 100M devices (7%) in the last 11 months (end of Jan-18 to end of Dec-18).
• The well-known, but still noteworthy, negative on the quarter was iPhone hitting a wall in China, with Greater China revenue down 27% and overall iPhone revenue down 16%.
• Decelerating App Store subscription growth was a focus on the call. While subscription growth declined to 33% y/y vs 50% last quarter, the company has consistently added 30M paid subs each of the last four quarters.

Apple as a Service Theme Intact

The change in reporting metrics lays the groundwork for an accelerated (2+ years) investor view that Apple is becoming more of a services business. Apple as a Service is the notion that the company is transitioning from primarily manufacturing and selling devices to maintaining and satisfying a large and growing customer base with ever-improving hardware and an increasing portfolio of software services. Growth of the installed base of 100M devices to 1.4B, in combination with 19% growth in Services revenue and 33% growth in paid subscriptions all represent confirmation of the Apple as s Service theme.

5G Opportunity

While we don’t expect 5G-enabled iPhones to ship until late 2020, anticipation will begin to build in 2019 for ways to play the 5G rollout in 2020 or 2021. 5G will be the biggest new iPhone “feature” since the larger-screen iPhone 6 in 2014. Investors will be talking a lot about 5G as competitors like Samsung will likely be first to market. However, concerns about Apple’s timing are misguided because US coverage will be negligible in 2019 and early 2020, and the experience won’t be great—certainly not enough for iPhone users to defect.

Continue to Expect Apple Will Be the Best Performing FAANG Stock in 2019

We see Apple shares as fundamentally undervalued at 12x next year’s earnings with significant growth opportunities still ahead. Despite the rough start to 2019, we believe the theme of Apple as a Service will slowly take root this year. Apple’s new reporting methodology will help focus investors on revenue and earnings growth, which should advance the view of Apple as a Service. This greater confidence in revenue and earnings visibility should be positive for AAPL’s multiple as well. As mentioned above, in 2019, we also expect 5G anticipation to be a positive for AAPL shares.

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