Apple (NASDAQ: AAPL) stock got off to one of the worst starts in the market in 2019. Within days of the start of the year, Apple stock was down 10%. Apple cut its guidance and warned of slowing iPhone sales and trade war headwinds.
A wave of analysts downgraded the stock and cut price targets. It’s not the first time Wall Street has written off the most valuable public company. And it’s not the first time Wall Street has been dead wrong.
Trade Deal Fears
The biggest part of the Apple stock bear thesis in early 2019 was China. For years, Apple has targeted the massive, high-growth China market as the centerpiece of its international expansion.
Apple’s China revenue accounted for about 18% of its total revenue in the fourth quarter. It was down $5 billion from a year ago. Understandably, fears of a total breakdown in trade talks between the U.S. and China have weighed on Apple stock.
Less than four months after Apple’s guidance cut, trade talks appear to be progressing nicely. The Financial Times reported on April 2 that negotiators from the U.S. and China have now come to agreement on most of the outstanding trade issues.
Wedbush analyst Daniel Ives says even if a trade deal is not completed in the next several weeks, Apple stock investors can breathe a sigh of relief:
“Our near-term take is that the additional tariff around iPhones and laptops is now off the table, no further supply chain disruption will be on the horizon, [and] closer cooperation around the growing IP theft issue in China is front and center and a potential positive for US tech vendors.”
Trade Deal Inevitable
The U.S. and China may not reach a deal tomorrow, next week or next month. But I agree with Warren Buffett’s recent take on the trade war.
“I generally think when two very smart countries have something very important at stake they’ll end up making rational decisions,” Buffett said in an interview with CNBC.
Parties on both sides of the trade dispute can argue which country is getting hit harder by the trade war. But both countries are objectively suffering. It’s in everyone’s best interest to reach a deal. It’s going to happen, it’s just a matter of when.
Looking past the trade deal, Ives says China is still a huge opportunity for Apple. Ives estimates there are between 60 million and 70 million active iPhones in China that are due for upgrades within the next year and a half.
iPhone Pricing Key for Apple Stock
Ives says Apple’s major misstep in China in the fourth quarter was that it overestimated its pricing leverage on its lower-end iPhone XR model. Apple has already cut prices on the XR in China. Ives says more aggressive price cuts in coming quarters should help beef up demand.
“Cutting prices in China on XR by up to 20% and pulling forward roughly 15 million-20 million iPhones (based on our estimates) over the next 3-6 months that would otherwise sit idle waiting for the next release, or worst case, move to lower priced competition is key as the last thing Apple can risk now is writing off an entire upgrade cycle in China,” Ives says.
Fortunately, according to Morgan Stanley, Apple’s pricing cuts in China have helped the company gain back lost market share in China so far in 2019. As long as Apple can avoid driving its iPhone customers into the arms of competitors in China, it has another crack at talking those 70 million Chinese iPhone users into an upgrade when it rolls out its next batch of phones in September.
This time, Apple will likely take a much more conservative approach to pricing out of the gates rather than risk losing market share. Margins may not be as high as Apple has hoped. The good news is that profits have never been an issue for Apple. Its primary objective in China is to keep/grow its user base as it shifts its strategy from selling devices to better monetizing its customers and growing its Services revenue.
Yes, China has been a major problem for Apple in recent quarters. Yes, Apple has made missteps in China. Fortunately, the damage can and will be undone, especially if the trade war reaches a timely resolution.
Wedbush has an “outperform” rating and $225 price target for AAPL stock.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.