Why Apple's troubles are not over yet

The smartphone market is struggling, with market penetration moving towards saturation and sales becoming stagnant. Should investors now dump Apple?

Research has shown that 71% of market movements are now the result of macroeconomic trends, while just 29% are the result of bottom up company specific news. When it comes to Apple’s recent market woes, Tim Cook, the company’s chief executive, would much rather pin the blame on the former.

Following the announcement at the start of 2019 that its expected revenue for the last three months of 2018 was $84 billion, down from a forecast of at least $89bn, the iPhone maker’s shares fell by almost 10%. While it is not uncommon for firms to downgrade their sales forecasts, in the case of Apple it was the first time it had revised its guidance to investors in more than 15 years. As a result, investors dished out a punishment to the share price,

The revision, said Cook in a statement concerning the company’s revenue report, was primarily the result of China’s economic slowdown. He noted: “The government-reported GDP growth during the September quarter was the second lowest in the last 25 years.” As a result, unit sales of iPhones in China declined.

There is some truth to this. Chinese authorities have been tightening financial conditions in attempt to reverse the large build up of debt in its economy since the 2008 crisis. This has also included a crackdown on consumer finance.

Slowing economic growth in China, however, is not the whole story. Until recently, Apple and other western consumer brands had relied on growing sales from the region as the Chinese middle class swelled and opted for high status, often western, brands. That momentum is now cooling. As Roger Jones, head of equities at London & Capital, the wealth manger, notes: “Emerging market economies now have much higher penetration rates.”

Chinese consumers now have a growing choice of smartphones, with domestic producers offering products of equal quality and brand status. As Walter Price, manager of Allianz Technology trust points out:  “The iPhone is losing share in a saturating smartphone market, especially in China.”

This is particularly a problem in China, says Ben Thompson, a former Apple employee and now business commentator at Stratechery, where Apple has not been able to secure such a hold on customers as it has elsewhere.

He notes that in much the rest of the world, Apple’s iOS software locks consumers in to the company’s hardware products, allowing it to enjoy a customer loyalty rate of around 80%. In contrast, in China there are more “cross-platform Chinese-specific services, particularly WeChat”.

As a result, Chinese customers have less loyalty to the brand and therefore Apple is more vulnerable to changing macroeconomic conditions. Thompson writes: “Apple is far more exposed to challenging macroeconomic conditions in China than they are elsewhere thanks to their relative lack of a moat.”

However, Apple’s problems are not just confined to China and other emerging markets. Jones adds: “The developed market have gone ex-growth as consumers feel less compelled to upgrade every year.”

He notes that historically mobile phone manufactures were technology driven, progressively introducing new innovations from calls and text messages to the all-encompassing smartphones of today. However, he adds: “The next leap forward in technology is not apparent and if this doesn’t materialise then consumers will not feel compelled to upgrade and prices of units will fall as production costs depreciate (as with all technology hardware).”

Further potential trouble is also down the road. He notes that Apple’s current problems in developed markets “have all happened in a supportive consumer backdrop.” If consumers see more pressure on disposable incomes as well as employment trends start to reverse, “trying to get upgrades into more expensive phones with no massive technology uplift will be impossible.”

This stagnation of unit sales of smartphones has instead seen Apple increase its focus on other revenues streams, principally digital services. While this may take a long time to develop, says Jones, it should “provide a higher margin…and more visible recurring revenue stream.”

Apple’s troubles does not mean investors should necessarily dump the stock. Instead, the company should now be viewed in a different light. Rather than a growth stock the company should now be seen a slow growth value stock, says Price. In particular, one with a generous share buyback scheme and a good cashflow to support it. Whether that makes Apple appealing depends on the investor’s goals. “We currently hold a position of 1.8% against the benchmark of 10.4% so are very underweight,” says Price.

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