Apple (NASDAQ:AAPL) stock has continued to face headwinds in China which has led the company to offer another round of massive discounts. Reuters has reported that Suning.com and Pinduoduo have reduced the price of iPhone XS by 1,000 yuan (approx. $150). Suning.com is also offering a whopping 2,000-yuan discount (nearly $300) on iPhone XS Max while JD.com is offering 1,700 yuan discount. These massive discounts will hurt the margins — and the outlook towards Apple stock.

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While Apple has focused on trade-in deals in the domestic U.S. market, it has opted for heavier discounts in China.

In its most recent quarterly statement, Tim Cook mentioned that the company would absorb any negative impact due to currency fluctuations instead of passing them on to customers. The end result is that we could see a major decline in operating margin in this quarter. And from this quarter on, AAPL stock will also not have the buffer of lower income tax provisions on a year-over-year basis.

Investors should closely look at these factors before making a decision on Apple stock.

Another Round of Discounts for Apple Stock

Many online retailers in China had offered substantial discounts in January. However, those discounts were limited to iPhone XR and older models of iPhone. The latest price cuts, in contrast, have included iPhone XS and iPhone XS Max.

The level of discounts on these products is also much bigger. The most likely way these resellers are able to offer this level of discount is if Apple has offered them cheaper wholesale prices.

Also, Tim Cook mentioned that Apple would be offering discounts internationally to make up for the weaker local currencies. The dollar is much stronger than the year-ago quarter, making the iPhone more expensive in both China and Europe. The impact this could have on Apple stock is often underestimated. 

What Does It Mean for AAPL Stock Sales and Margins?

The January discounts helped improve sales. Alibaba saw 76% increases in iPhone sales while Suning reported 83% increase in sales. At that time, Suning was selling iPhone XR for 6,199 yuan while Apple’s own online store was selling iPhone XR for 6,499 yuan, only 300 yuan more.

However, in the current round of price cuts, the scale of discounts is much higher and includes iPhone XS and iPhone XS Max. This points to disappointing iPhone sales when they’re at full price in China. Massive discounts might help Apple stave off  a sales decline similar to what it showed in the last quarter. At the same time, it will have a significant negative impact on the margins. Giving a straight $150 or higher discount on every iPhone is a big hit on the bottom line.

Apple’s operating margin in the last quarter was 27.69%, down from 29.76% in the year-ago quarter. A fall of 207 basis point in operating margin is quite high, but we could see a bigger decline in operating margin in this quarter due to the heavier discounts.

Impact of Trade Deal

Apple has already guided for lower revenue compared to the year-ago quarter. The company has estimated quarterly revenue between $55 billion and $59 billion, while in the year-ago quarter it was $61 billion. If Apple reports modest revenue despite heavy discounts, it will further negatively impact Apple stock.

A positive trade deal between U.S. and China is also unlikely to boost sentiments if the dollar remains strong. That’s partly thanks to rapid market share growth of Huawei within China. Huawei has been aggressively pricing its smartphones in the mid-tier segment of $400-$600, which increases the competition for Apple’s older iPhones.

The older iPhones contribute a significant share to Apple’s unit shipments and revenue base. Stronger competition from Huawei and other Chinese OEMs could force Apple to give discounts on the older iPhones. This could also impact the bottom line in the next few quarters.

Provision for Income Tax

Apple stock has rebounded strongly in the past few weeks. It has made up for all the losses suffered after the surprise announcement of a decline in revenue made by Tim Cook in early January. However, the headwinds which caused the revenue dip in China in the last quarter are still there. Given the level of discounts, we could see a decline in margins as well as the top line.

Apple has already made a substantial reduction in income tax provisions in 2018 due to tax cuts. In the quarter that ended in March of 2018, the income tax provisions were $2.3 billion, down from $3.6 billion in the year-ago quarter. This helped the company report better net income, even though the margins were falling. Apple will not have a similar buffer in this quarter. Hence, we can see a significant decline in net income and EPS. This should be a major headwind for Apple stock in the near term.

Investors should closely look at the impact of iPhone discounts in international regions and the impact on margin and net income.

Investor Takeaway

Reuters has reported that third-party sellers in China are offering big discounts. It is likely that Apple has reduced the wholesale prices of iPhones for major sellers. We should see lower margins in the iPhone segment in this quarter as Apple tries to increase its unit shipments in international regions.

While Apple stock has rebounded since early January, Apple continues to face structural headwinds in China. The company also does not have a buffer of falling tax provisions which could boost net income. Eventually, we could see a big decline in operating income and EPS in this quarter. And that should lead to a major correction in AAPL stock in the near term, so be cautious.