By K C Ma and Bilal Hashmi
Apple (NASDAQ: AAPL) has long been spared customs clearance. It was the only technology company that received the blessing of the White House to be exempted from US tariffs on Chinese imports. Both the Apple Watch and the AirPods have been removed from the list of products that should initially be subject to import duties of 25%. The New York Times noted that they are among the 300 product lines removed from a previous draft. Items on display include smartwatches, Bluetooth devices, bicycle helmets, plastic gloves, high chairs, game pens, and certain chemicals. It was not until Tim Cook's infamous downside statement that Apple's lack of direct customs risk was confirmed by the absence of the "markdown" in the stock price, which is clearly reflected in the close relationship between Apple's actual share price and the pure fundamental price (Figure 2). However, the above optimism will only last until the end of 2018.
Following the collapse of trade talks and the resumption of tariffs, the US's continued ban on Huawei opened the door to China's ban on retaliating against a US company of similar importance. The market was eventually forced to uphold the "unthinkable" notion that China could ban the sale of iPhones by Apple in response. It was Bala Reddy of Goldman Sachs who wrote for the first time:
"If there was a ban or other restriction on Apple products in mainland China, we estimate Apple's annual EPS exposure to be around 3 , $ 35 per share. "
Reddy did not mention the likelihood of such a ban, reducing his 12-month bullish target of $ 184 to 14.7x forwarding price to $ 178.
Alternatively, in this post, we examined Apple's impact on revenue and stock price implications of a possible China iPhone ban, as Apple's decline in iPhone sales has begun long before the trade dispute. The sheer size of Apple's Apple iPhone sales volume, with or without an impending ban, makes sales a more critical factor for Apple shareholders.
China's challenges ahead of the Huawei ban
China's smartphone shipments fell 11% from 121.3 million units in the fourth quarter of 2017 to 107.9 million units in the fourth quarter of 2018. The Chinese smartphone is in one Recession and has fallen in the last five quarters. It has suffered from prolonged replacement cycles and weak consumer spending due to uncertainty in the trade war. Due to patent litigation with Qualcomm (NASDAQ: QCOM) and high prices, iPhone shipments in 2018 dropped 22% per year. In eight of the last twelve quarters, sales were down on the previous year. Apple is currently in fourth place of the five major smartphone manufacturers, with a market share of 10% in China in the fourth quarter of 2018.
After the Huawei ban: How many iPhone in China are at risk?
To Appreciate the Impact on Apple As a potential ban on the Chinese iPhone, I must first assess the iPhone units currently sold in China. Apple announced that in the fourth quarter no sales for iPhone, iPad and Mac will be reported. Apple CFO Luca Maestri said that "the number of units sold in one quarter is not representative of the underlying business situation." In a sense, the decision not to release iPhone numbers means only a slowdown in sales growth for its flagship product. Since Apple has not reported any shipments for certain geographic segments, we must rely on the estimated channel stock of Canalys and IDC. For the second quarter of the fiscal year, Apple shipped an estimated 6.975 million iPhones, or 23% of the total delivered iPhone, 46% less than a year ago or 59% sequentially (Figure 1A). This is the worst decline in two years. In fact, fewer smartphones were sold in China than Xiaomi (XI), Vivo, Oppo and Huawei. In terms of sales, Apple's second-quarter revenue in China was $ 8.8 billion, down x% from the previous quarter and x% lower a year ago (Figure 1B).
As the decline in the second quarter was before the Huawei ban, the most commonly cited reasons of increasing nationalism and the slowdown in China are both a consequence of trade disputes between the US and China. It is clear that the decline in iPhone deliveries in Q2 in China was more of a Chinese problem, as shown by the record 23% drop in iPhone shipments in China. If China reacts to the iPhone ban, its immediate losses amount to nearly $ 49.4 billion a year (the last 4 quarters in Figure 1B) or 18.6 percent of Apple's total revenue.
iPhone prohibition on share loss
The task is to identify the revenue risk as it is on record. The more elusive, however, is to turn revenue changes into stock price changes. For that, I'm relying on a stock valuation model that correlates company sales with stock price because it's Apple's iPhone sales in China. If a stock is valued on the basis of its multiple of the selling price, the percentage change in the selling price can be approximated by the percentage change in sales and the percentage change in selling price:
% Change in selling price =% Change in sales + Percentage change in sales price P / S
Since the P / S multiple depends on future revenue growth, the percentage change in P / S must first be estimated with the expected change in revenue growth. Figure 2A shows for Apple a clear, positively correlated relationship between P / S and revenue growth rate. In particular, the P / E ratio changes by 1% for every change in Apple revenue growth rate of 0.03.
Show how the valuation model is applied when Apple's revenue growth is expected to increase by 10%. and the P / E ratio will also rise 9% due to the correlation, the stock price will rise by 19% overall. In the case of Apple, it is estimated that current nationalism will cost 3% to 5% of Apple revenue for the next 12 months if China does not ban iPhones. As a result, Apple's stock appears to be losing 6% (Table 1). If China decides to ban the iPhone, Apple is expected to lose $ 50 billion (-18.6%) of its total revenue for the loss of nearly 43 million iPhone units per year, plus the associated loss for P / S ( -10.63%). Apple's share is expected to fall 30% (Table 1).
The chance of an iPhone ban in China
Between China's nationalism and the iPhone ban, Apple's stock is expected to lose between 6% and 30%. But analysts' share price and new price target has fallen by less than $ 10 or 5% since the Huawei ban. The fact that share prices do not fully reflect the extent of possible revenue losses points to a glimmer of hope. The market may have seen through the reality that China will not risk local employment and economic growth, which offers the same apple that it wants to ban. The market may have seen, due to the complexity of international trade, that the announced ban or embargo can be easily "tempered" by companies, as were the duties. Or the market may have seen through the complexity of the trade negotiations that the "surgical" ban on Huawei can be reversed quickly when it was introduced. Less than a week after the ban, Reuters reported:
"The United States has temporarily suspended trade restrictions on China's Huawei" to keep disruptions to its customers as low as possible Founder of the world's largest telecommunications equipment manufacturer said, meant little, because it was already prepared for US actions. "
Finally, the sign of reason could have already surfaced. In late April, before Trump's Huawei ban, Apple reported slightly better iPhone sales in China. CEO Tim Cook told analysts during a teleconference:
"There is an improved trade dialogue between the US and China, and in our view, this has affected local consumer confidence, and there is a positive path."  Disclosure: I / we have no positions in the above stocks and no plans to open positions within the next 72 hours. I wrote this article myself and it reflects my own opinion. I can not get any compensation for it (except from Seeking Alpha). I have no business relationship with a company whose shares are mentioned in this article.