China’s slowing investment bubble will hurt Apple’s sales growth (Part 1 of 9)
Investment in China hits a peak and could slow
The below graph reflects the relative performance of key technology shares for Google (GOOGL), Apple (AAPL), China’s Baidu (BIDU), and Russia’s Yandex (YNDX). As we noted in a prior article, China saw spectacular wage growth in 2012 of around 30%. Wage growth is now closer to 12%. Growing wages and an exceptionally high level of investment in China have supported technology sales for companies like Apple. However, as post–2008 crisis stimulus measures fade, it might appear that spectacular growth rates in wages and investment may decline to merely very high levels of growth. This series examines the changes in China’s overall investment portion of its economy and considers the impact for consumer-oriented technology firms like Apple and Baidu, as well as Google and Russia’s Yandex.
For more detailed comparative analysis on Google (GOOG) versus Yandex (YNDX) and Baidu (BIDU), please see Market Realist Smita Nair’s series Evaluating Yandex versus other key search engines.
Apple’s earnings versus prior quarter
Apple earned $8.44 billion in China sales in the quarter ended in December 1013—up 29% year-over-year. U.S. revenues were $20.09 billion and the European revenues were $13.07 billion. Revenues rose 29% for China, 11% for Japan, and 5% for Europe, though they fell 1% for the U.S. In the most recent quarter announced in April, Apple had nearly $10 billion in revenues from China. In comparison, in 2011—for the entire year—Apple saw $12.5 billion in revenues from China and a mere $2.8 billion in 2010. Given these growth rates, it’s easy to see why China is so important for Apple, and why China’s Baidu also has a vested interest in the continuation of robust sales of technology and telecom in China. Apple just began breaking out Chinese sales data formally in the quarter ending December 39, 2013. As U.S. revenue growth rates slow, it might seem that pointing to growth rates in China is prudent. Given the explosive growth Apple has seen in China, it’s easy to see how China’s revenues could become a more important focal point for U.S. investors than the slow growth markets of the USA or Europe. At current growth rates, China could become a bigger market than the U.S. within ten years.
Apple in China: Is Apple saturated in Tier I and Tier II cities?
The Wall Street Journal’s Juro Osawa points out that smartphone shipments in mainland China enjoyed robust growth post–2008 crisis as government stimulus rolled out and wage growth in China exploded. 2012 was definitely the year of the Dragon in China and the year of the iPhone for Apple. However, it would appear the wealthier urban cities have been well penetrated at this point and that future success for Apple in China could become more dependent upon Apple’s partnership with China Mobile to grow sales in the more remote areas. With 40% of China’s mobile users using smartphones, it’s easy to get optimistic about more smartphone sales in China. However, as Osawa points out, it might seem that those who could afford the higher monthly fees of smartphone connectivity have purchased smartphones, and that China’s more rural population is still not ready for the cost of smartphones. Wage growth in manufacturing is encouraging, though as the below graph suggests, the average worker in China isn’t anticipated to be a sudden source of ongoing 30% revenue growth for Apple’s smartphones or computers in China.
Google in China: Baidu owns keyword search, Google in contextual advertising
As the below chart suggests, Google remains strong as a contextual advertising provider, though it seems to be out of China’s much larger keyword advertising, dominated by Baidu. However, search engine revenue growth in China is around 40% for 2013 at 40 billion yuan, and iResearch estimates revenue to double to nearly 100 billion yuan in 2017 ($17 billion). Google ended 2013 with $16.86 billion in consolidated revenue and 17% growth. So far, Google seems to have 16% of China’s $6.6 billion market, or $1 billion. Perhaps revenue for Google in China also will also double to $2 billion by 2017. While this is also a strong growth rate (similar to iPhone growth in China), relative to iPhone sales, search engine revenue growth in China won’t be as critical to Google’s revenue growth as iPhone sales will be for Apple. Apple’s overall revenue growth over the next few years will be more China-dependent than Google’s. Apple is the fifth largest smartphone company in China, with 7% of the market. The market leaders are currently Samsung, Lenovo, Coolpad, and Huawei. Though Apple current sits in sixth place in terms of market share, many expect that Apple’s new partnership with China Mobile will grow their market share significantly.
Key word advertising is key for Baidu and contextual advertising is key for Google China
As the below graph reflects, Baidu dominates China’s keyword advertising landscape, while Google seems to occupy a significant niche of its own.
Asian equity outlook
The weakening yen and relatively flat wage growth in Japan have supported Japanese markets, as reflected in the Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan (EWJ) ETFs. Aggressive monetary policy in the USA has supported the S&P 500, as reflected in the State Street Global Advisors S&P 500 SDPR (SPY), the State Street Global Advisors Dow Jones SPDR (DIA), and the Blackrock iShares S&P 500 Index (IVV), which have been up nearly 18% over the past year. However, tapering is now in play, and higher rates in the five-year Treasury could cool U.S. valuations going forward. Given China’s current financial challenges in the banking system, both the U.S. equity markets and the Abenomics-driven Japanese equity markets may continue to outpace China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). However, if U.S. valuations continue to increase over the year, China’s valuations should become increasingly compelling. With FXI’s key holding, the banking flagship Bank of China, trading at a 0.84 price-to-book ratio and a 4.95 price-to-earnings ratio, you have to wonder how much lower Chinese banks and financials could go.
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