After Apple (NASDAQ: AAPL) reported its earnings recently, many analysts predicted that Apple’s business prospects in China would stabilize. However, America’s recent tariff hike and the level of negative rhetoric on both sides are big headwinds for Apple stock.
In the last two quarters, Apple has blamed the slowdown of its sales in China on the country’s economic weakness. However, it should be noted that big, Chinese consumer-facing companies like Alibaba (NYSE: BABA) have reported that their core businesses .are growing over 40%. This means that the decline of Apple’s revenue in China is due to company-specific issues.
Increasing the Stake for Apple Stock
In recent tweets, President Trump has ramped up his rhetoric on trade. At the current junction, it’s difficult for either side to back down. This means that a successful resolution to negotiations in the near- term is unlikely.
Those who plan to hold Apple stock over the long-term should also focus on future trends developing within China. The recent tariff hike and rhetoric reduce the probability of an amicable trade deal. Even if a mutually acceptable trade deal is reached, the trade rhetoric of the past few months will have a negative impact on Apple’s business and brand within China and, by extension, on Apple stock.
The Chinese government wants local Chinese brands to increase their market shares at Apple’s expense. For its second quarter which ended in March, Apple reported $10.2 billion of net sales from the Greater China region. That’s a decline of 22% from the same period a year earlier.
Last year, Apple generated $51.9 billion of revenue from China, equating to 20% of its total sales. After two quarters of fiscal 2019, it’s clear that its China sales will easily decline by 20%-25% for the full year. That will have a big negative impact on Apple stock.
Lack of Ecosystem in China
Apple’s biggest strength has been its strong ecosystem which increases the loyalty towards its products. However, in China, its ecosystem is weaker than in western markets. The main reason for that is the impact of Tencent’s (OTCMKTS: TCEHY) WeChat, which provides almost all the services required by customers, including payments, communications, music, games, e-commerce and more.
Late last year, Tencent announced that its mini-programs have one million apps and over 200 million daily active users. These mini-programs reduce the need to visit Apple’s App Store. WeChat’s platform will continue to grow stronger, adversely impacting Apple’s ecosystem within China.
Apple has been trying to improve the popularity of its Apple Pay within China for a number of years. However, AAPL has found it difficult to overcome the duopoly of Tencent’s Wepay and Alibaba’s Alipay. Last year, Apple started accepting Alipay within its retail stores., showing the massive hurdle faced by Apple in this area. The current trade tensions make its weaker ecosystem in China more crucial.
In the last two earnings report, Apple’s management has hinted that its poor sales in China are due to the slowdown of the economy. China’s GDP growth has certainly dropped slightly in the last few quarters. But there has not been a massive decline in consumer demand. Apple reported a 22% decline in its net sales in China in its March quarter and another 26% in the previous quarter. On the other hand, Alibaba reported 40% growth in its core commerce sales last quarter. As a result, the decline in Apple’s China sales seems to be a largely company-specific issue.
In its recent report, IDC has estimated that Apple’s unit shipments in its March quarter declined by a whopping 30.2%. At the same time, China’s Huawei has shown over 50% growth. Most of the growth of Huawei has been in the domestic Chinese market. Huawei has been aggressively promoting its products and providing deep discounts.
That has forced Apple to reduce its own prices. In the last few weeks of the March quarter, Apple gave massive discounts on the newer iPhones in China. The discounts on the iPhone XS Max were as high as 2000 Yuan (around $300).
A Perfect Storm in China
The recent jump in Apple stock after the earnings shows that Wall Street is ready to give Apple a pass for poor sales in Greater China. But the company can experience a perfect storm as a number of negative factors impact its business in China. Apple stock has been hurt when there were tensions between U.S. and China in the past. Even if a deal is made, the Chinese government can hit Apple with regulatory hurdles, hurting Apple stock.
It would be nearly impossible for Apple to replicate in China the services it has launched in the U.S. There are already major domestic tech players in China which provide news, music, video, payments, and communication services. The revenue base of Apple’s App Store can be further eroded due to the growth of WeChat’s ecosystem.
Finally, Huawei has a big home team advantage in China. It will also be launching 5G services sooner than Apple. It would be difficult for Apple to rely solely on its brand image to counter Huawei. The recent price cuts by Apple in China are a sign of the company’s lower pricing power in this region.
All these factors will continue to hurt Apple’s net sales in China for the next few quarters, reducing the extent of any bullish runs by Apple stock.
The Bottom Line on AAPL Stock
The Greater China region contributed close to 20% of the total revenue of Apple in its last fiscal year. In the last two quarters, Apple has reported year-over-year declines of 26% and 22%, respectively, in net sales from this region. AAPL could experience further deterioration in China, depending on the result of the trade negotiations and the growth of its local rivals. It would be difficult for Apple to replace this lost revenue .
It should be noted that the 22% decline in net sales in the Greater China region came despite heavy discounts offered by Apple in March. The near-term movement of Apple stock will heavily depend on its ability to generate decent results in China.
As of this writing, the author did not own shares of any companies named.
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