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A Recent Regulatory Change in India Has Improved Apple's Growth Opportunities

Apple Inc. (NASDAQ:AAPL) is among the most-followed companies in the world. Last September, however, many analysts and investors missed a critical development in India that could have a massive impact on the company's earnings in the future.

An overview of the recently announced regulatory changes in India

In late August, the Indian government announced it is liberalizing foreign direct investment (FDI) standards in a bid to attract funds from multinational companies trying to tap into the Indian market. Up until that point, foreign-owned companies were expected to source at least 30% of their products in India in order to be allowed to open their own stores. Since iPhones are mainly assembled in China, the company could not find a way to meet this requirement, which resulted in being unable to open its flagship Apple Stores in the country.


Nirmala Sitharaman, the finance minister, announced that international companies would be exempted from the previous sourcing rules under the condition of agreeing to invest $200 million in the country.

According to Livemint, just after this decision was made, an Apple spokesperson issued a statement about this development:


"We love our customers in India and we are eager to serve them online and in-store with the same experience and care that Apple customers around the world enjoy. We appreciate the support and hard work by Prime Minister Modi and his team to make this possible and we look forward to one day welcoming customers to India's first Apple retail store."



During the earnings call in 2018, company management attributed the low profit margins seen in India to the excessive price discounts offered by the retail partners with whom Apple is collaborating with to execute sales. These partners include Amazon India, Flipkart and Paytm.

Now that the regulatory landscape is changing, the company will be in a better position to market and sell its products directly to Indian consumers.

Apple has found it difficult to penetrate the Indian market thus far

While this might come as a surprise to many, Apple's market share in the Indian smartphone market is just 1.2%, according to the latest data from Counterpoint Research. On a global scale, the company has accounted for more than 10% of the market throughout the last decade.

Global market share of smartphone vendors

Source: Statista

The price-sensitive nature of Indian consumers, which is evident by looking at the major players in the smartphone market, is the primary reason for Apple's disappointing performance in this region.

Source: Counterpoint Research

With recent regulatory changes and expected growth of the smartphone market, Apple's future looks much better in India

The supportive legislative environment will enable Apple to market its products directly to Indian consumers. Additionally, the unfavorable discounts will finally come to an end as the company will become the sole decision-maker in regard to price. It will be able to gather important information, such as purchasing patterns and consumer tastes, as well, which could then be leveraged to strategize a marketing plan that actually works in this Asian nation. An added benefit for Indian consumers is that they will finally feel the value of Apple's brand with the establishment of its flagship stores, which could further strengthen the ability of the company to reach a wider audience.

The recently launched low-price devices will also help the company's operations in India. For instance, the iPhone 11 starts $50 below the iPhone XR. Also, the price of the iPhone X has been reduced to $599 from $999 and the iPhone 8 will now cost $449.

The expected economic growth in the country will also be a driver for smartphone manufacturers as the rise of a middle-income society will lead to higher discretionary spending on luxury items. PricewaterhouseCoopers projects the Indian economy will grow faster than the U.S. and China in the next decade, and eventually become the second-largest economy in the world by 2050. This will be a tailwind for Apple.

There is a lot of room to grow in this market as well. For instance, the smartphone penetration in India as a share of total mobile phone users is 29% as of the second quarter, according to data from Statista. However, this is expected to improve to 36.2% by 2022, which presents an opportunity for Apple to drive revenue even if the market share does not grow.

The company is trying to tap into the over-the-top video streaming industry in India as well. Apple TV+, which will be launched globally on Nov. 1, will only cost $4.99 per month in India, whereas Netflix (NFLX), Amazon Prime and Hulu all charge upward of $10 per month for a subscription. The lower starting price coupled with top-quality shows and movies should help the company gain traction.

Apple's valuation is a bit tricky, but long-term investors need not be worried

Shares are trading at the highest price-earnings ratio it has traded in the last five years (20.8), which should catch some investors' attention. The company certainly has growth prospects resulting from its attempts to emerge as a services company. Apple is tapping into the billion-dollar health care industry, and the wearables segment, which includes Air Pods and Watch, is also growing. However, the company revealed last year that the number of iPhones sold is declining.

According to data from Reuters, the median analyst estimate for Apple's stock is $233, so the share price of around $237 on Wednesday suggests that shares are fairly priced. However, long-term investors would still be able to unlock value when the company reaps the benefits of its improving prospects in India while gaining traction in its target industries such as health care and video streaming.

Conclusion

For the first time in India, Apple is in an excellent position to grow its revenue and earnings. Management has identified this opportunity and has launched devices and subscription services with a view of gaining market share in this region. Even though shares are fairly valued, long-term-oriented investors should still be bullish on the company's prospects.

Disclosure: I own Apple.

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This article first appeared on GuruFocus.