Monday 7 January 2019 9:26 am Markets Talk

Apple profits warning a red flag on China, but company also to blame

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For a while now there’s been an adage in the markets that as long as Apple was doing fine, everyone else would be OK. Therefore, Apple’s rare profits warning is a red flag for market watchers. The question is to what extent this is more Apple-specific, or more macro? Certainly, the shock letter to investors from Apple has sent shockwaves through the markets – Apple shares tanked more than 7 per cent in after-hours trading, while we saw an ripple effect not just on the usual suspects like semiconductor producers, but across the wider market in general. Apple stopped disclosing iPhone unit sales in November, a move that spooked investors and analysts alike who decided that meant that iPhone sales would be soft. Shares were already over 31 per cent lower in the last three months before the profits warning. Revenues are set to come in at $84bn, versus previous guided range of $89bn-$93bn. Gross margin was lowered to c38 per cent from a range of 385-38.5 per cent previously. A lot of this is Apple specific. The company has a very wide pricing range with its latest set of phones, which is confusing. It has failed to generate unit sales growth for a couple of years and has relied on higher pricing that has failed to carry through in the last quarter. Consumers are not upgrading quickly enough, not least because the higher pricing simply means it takes longer to pay off the debt taken on when purchasing on the phone – as seen in the growth of 3-year contracts over 2-year. But the warning also tells a lot about what is happening on in the broader global economy, specifically China. It tells us that China is experiencing a period of softness. Most of Apple’s revenue shortfall versus guidance, and over 100 per cent of its year-over-year worldwide revenue decline, occurred in Greater China across iPhone, Mac and iPad, the company said. It tells us that the trade war between the US and China is having a dampening effect on demand and activity. It is also a factor of dollar strength. Apple said that whilst it had anticipated some challenges in emerging markets, it ‘did not foresee the magnitude of the economic deceleration, particularly in Greater China’. Of course, we have been talking about a slowdown and possible hard landing in China for some years, but the new spectre of tariffs are a problem that is exacerbating the troubles in the world’s second largest economy. Reasons to be positive: Revenues from everything but iPhones are 19 per cent higher. This suggests very strong Mac and iPad sales were strong, whilst Services continues to make new records on higher installed base. Indeed, the shift to a services business continues, which ultimately should command higher multiples – certainly than where we are now post this fall with Apple now about 12x earnings. We note that the installed base of devices has risen 100m in the last 12 months. Investors are yet to really buy into the idea that Apple can be a services business and it is proving a painful process; but ultimately one that should succeed. And apart from China, things are not looking too bad at all. In fact, the company expects to set all-time revenue records in the United States, Canada, Germany, Italy, Spain, the Netherlands and Korea, as well as many emerging markets like Mexico, Poland, Malaysia and Vietnam.  
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