During the most recent earnings call, Apple Inc. (NASDAQ:AAPL) CEO Tim Cook glossed over the lagging performance in China. He noted: “We continue to be very enthusiastic about our opportunity in China.”
He ticked off various metrics, such as the double-digit growth for Macs, the Services business and the retail stores. Cook then blamed issues like foreign exchange, the difficulties of year-over-year comparisons and even the sluggish tourism activity in Hong Kong.
And yes, it was enough to temper concerns. Since the earnings report, AAPL stock is up about 10%.
Despite all this, I still think there should be more of a focus on China. Note that revenues for the region — which includes Hong Kong and Taiwan — plunged by 14% in fiscal Q2 to $10.73 billion. It was actually the fifth consecutive quarterly decline. To put things into perspective, the sales were a hefty $16 billion just two years ago.
IDC also provided some ominous data, which should certainly instill discomfort for holders of AAPL stock. During the first quarter, iPhone shipments dropped by a grueling 27% to 9.6 million units, making the company the No. 4 player in the market (with only a 9.2% share).
OK then, so why does China matter — and why could it ultimately weigh on AAPL stock? First of all, the country is just too massive to ignore, with 1.3 billion people. According to the World Bank, China “has been the largest contributor to world growth since the global financial crisis of 2008.”
Basically, the country can move the needle for AAPL stock. Keep in mind that China represents about 20% of Apple’s top line.
The Achilles Heel for AAPL Stock
One of the biggest issues for AAPL is that China’s market is intensely competitive. The company must fight against fierce rivals like Xiaomi, OPPO, Vivo and Huawei. They not only have the advantages of understanding how to deal with the nuances of the government but have also been focused on innovation. Oh, and the pricing on the smartphones have generally been much cheaper vs a similar iPhone model.
But there is another factor — that is, Tencent Holdings Ltd (OTCMKTS:TCEHY). The company’s WeChat app, which has over 1 billion users, has become essentially a mobile OS. Because of this, many of Apple’s core services like the iCloud, iTunes and Apple Pay have not really caught on. So when a user is considering moving to another device, the switching costs are not as substantial. This is why the retention rate for iPhone users is 50% in China while it surpasses 80% in the U.S.
AAPL has been fighting back, such as demanding a 30% cut from any virtual tips provided through WeChat. But in the end, this may just alienate users and developers. Hey, why not just use a much cheaper Android smartphone?
Now, it’s true that the upcoming iPhone 8 could help reverse some of the problems. Yet China’s phone makers are not sitting still and will continue to innovate. And besides, there is even buzz that Tencent will launch its own smartphone.
Bottom Line on AAPL Stock
Part of the rally in AAPL stock has been due to the big move in the megacap tech stocks like Amazon.com, Inc. (NASDAQ:AMZN), Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) and Facebook Inc (NASDAQ:FB). But of course, there is also the potential impact of the iPhone 8 launch.
Although, it seems like much of all this is baked into the AAPL stock, with the forward price-to-earnings ratio at about 15X. As InvestorPlace.com’s Dana Blankenhorn has noted, this multiple seems “digestible in a bubble, but on the high side for Apple, historically speaking.”
So given that there’s a good bet that China’s problems will persist and there will be few catalysts until the iPhone comes out — which may ultimately be delayed because of the complexities of the new features — it’s probably best to hold off on AAPL stock for now.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is the author of various books, including All About Commodities, All About Short Selling and High-Profit IPO Strategies. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.