Apple (NASDAQ:AAPL) reported a 26.5% fall in revenues from greater China, with the claim that it was primarily because of slower economic activity in the region. Apple stock regained some of the losses suffered after the announcement of lower Chinese sales was made in early January.

However, other major companies in China have shown decent performance in the recent earnings. If we look at Alibaba (NYSE:BABA), the core commerce growth was 40% and there wasn’t any hint of a possible slowdown in growth in the next few quarters.

A recent report by foreign policy expert Ian Bremmer mentions the long term risk faced by Apple stock due to its business model in China. The privacy laws in China will impact Apple’s business model which relies heavily on the protection of consumer data. Apple could also face increasing competitive pressure from Huawei which is getting higher scrutiny by European Union and the U.S. government.

Performance in the Past

Improvement in business from the Greater China region was one of the major reasons for revenue growth under Tim Cook’s leadership. This was also a primary reason for the decent returns delivered by the Apple stock in the last few years.

Source: Apple Filings

Apple’s net sales in Greater China in FY13 was $25.4 billion. This increased to $51.9 billion in FY18, a compounded annual growth rate, CAGR, of 15.8%. The total net sales in the remaining regions increased by 7.8% on a CAGR basis between FY13 and FY18.

A core part of Apple’s business model is to sell premium products which have a high level of data security. The company has even refused to share customer data with intelligence services in the US.

According to Bremmer, the Chinese government could make higher demand for consumer data from Apple. This can hurt the demand among customers who value data privacy.

The Huawei Angle

Huawei has been facing greater scrutiny from the U.S. government as well as the European Union. A complete ban or major restrictions on Huawei can lead to similar headwinds for Apple in China.

Source: IDC

While the total smartphone shipments declined in 2018, Huawei saw robust growth of 33.6%. It is now marginally behind Apple in terms of unit shipments. Most of the growth shown by Huawei has been in China where it is launching new devices at an aggressive price and with more innovative features.

Apple still controls the premium segment of the market with its flagship iPhones, however, older models from Apple in the price range of $400 to $600 are facing increasing competition from Huawei and other local OEMs. These older models are very important for Apple stock as they deliver a good portion of unit shipments and revenue for iPhone segment.

Source: IDC, Bloomberg

We should also note that other foreign companies have also faced major backlash in the past few years. In 2012, there was a protest against Honda and Toyota which led to rapid fall in their sales in China. Apple could see similar decline in the near term as a retaliation for the restrictions on Huawei.

Short Term or Long Term

The most important question for investors in Apple stock is whether the recent decline in revenue in Greater China is short term or long term. In the guidance update in early January the management mentioned it “did not foresee the magnitude of the economic deceleration, particularly in Greater China.”

However, contrary to the claims of major economic deceleration, Alibaba has posted solid growth numbers in the recent earnings. The core commerce growth rate came at 40% on a YoY basis and Alibaba’s management was quite optimistic about future growth momentum.

Hence, it looks that the recent decline in Apple’s revenue in China is company specific. In the long term, there could be further regulatory or competitive pressures on the company in the Greater China region. This can lead to further deterioration of its business in this region.

In the last fiscal year, Greater China region contributed 19.6% to the total revenue base of Apple. It would be difficult for the company to make up for this lost revenue. Management had earlier promised strong growth in India and other emerging markets. However, it is unlikely that these markets will provide a revenue base similar to Greater China.

Price momentum of Apple stock is highly correlated with quarterly YoY revenue growth. If we continue to see future revenue decline due to headwinds in China, the bullish sentiment towards Apple stock can suffer. I don’t think that the challenges faced by Apple in China are fully priced in. If we see another quarter of poor sales in China, Apple’s stock could show a major correction in price.

Investor Takeaway on Apple Stock

Apple’s challenges in China are specific to the company and not due to wider economic downturn. The company is likely to face greater regulatory and competitive pressure in this region.

In FY18, Greater china contributed 19.6% of the total revenue for Apple. A continuous decline in this market will inevitably hurt the revenue growth rate in the next few quarters.

Investors should closely look at the headwinds faced by Apple in China and its possible impact on Apple’s stock.