I have written a few articles about Apple (AAPL) recently -- check out "Apple's Big Mystery Buyer In Q1 2012" and "Apple: Great Valuation, Dangerous Price Action" -- and I have observed from the comments on them that most of the bull case for Apple depends on China. I find that argument to be rather short term, though.
The latest news out of Apple confirms that the bull argument has a certain catch. Although the company is growing rapidly in China, news out of its home base is not so good. Apple's sale stats suggest that the company has reached saturation in the American market. It has actually failed to reach the consensus estimates in its home market.
Apple is a company that is very fairly valued, in my opinion, so I don't agree with the argument that it is undervalued and there will be further multiple expansion. I expect the stock to top out near $750 as the company will actually enjoy the benefits of Asian expansion for another four to five months. After that, however, I expect the company's margins to come under pressure and the stock price to gradually move back around the $500 level -- or maybe even lower, if there is an overall market correction. I also expect the stock to be quite volatile in the case of a market swoon in May, since there is a considerable buildup of momentum traders in the stock. That momentum crowd would sell heavily if market sentiment turns.
In this article, I would like to offer five reasons why depending solely on the growth from the Asian markets is not a sustainable strategy for Apple. In my opinion, the company is at a stage where it desperately needs to come up with a new product category to justify its valuation. Of course, by some accounts this is exactly the case and the company is preparing for some huge releases in late fall 2012. However, if it does not deliver exceptionally on those prospects, Apple cannot depend solely on Asia to compensate for the weakness in the American market. Here are the reasons why:
1. The outperformance in Asia seems solely to be a result of a lag in product distribution deals over there. Many investors contend that the recent outperformance of Asia is a result of the huge population and increase in purchasing power there. In my opinion, it is rather a simple consequence of the fact that Apple was able to fully distribute its products in Asia with a lag compared to the American market. The biggest example is the Chinese market, where the company has only reached satisfactory distribution levels in the last year.
In simple terms, Apple products sell better in Asia (especially in China) because they are newer in those markets and they enjoy the hype associated with a trendy product. Investors should consider the possibility that as Apple's products become more commoditized in Asia, as happened in North America, they might lose the initial product launch excitement and sales growth might decrease considerably.
2. Asians are incredibly luxury brand conscious. If Apple becomes commoditized and loses its trendy status, Asians will abandon the brand no matter the quality of the products. There have been some great discussions on Seeking Alpha about how the Chinese buy Apple products not because of their quality but because of the status symbol that they have become. While that effect is certainly true -- and in much of Asia, as opposed to only in China -- investors should realize that it cuts both ways.
If Asians buy Apple products not because of the quality of the products but because of the brand, then you carry the risk that your sales might collapse if some other brand or product category becomes popular in the next three years. Although Apple is considered to have a cult following, it should not be forgotten that much of that cult was formed rather quickly in the recent past. Investors should consider the risk that the same crowd that buys Apple products because of their popularity might very quickly shift to another brand or product if the next big thing comes from outside of Apple.
3. Although the economic growth in Asia is impressive, the average purchasing power in Asia is still quite low compared to North America. This argument applies to Asian countries ex-Japan and ex-Singapore. Investors should note that much of the economic growth in emerging Asian countries has come from investments in infrastructure as opposed to an increase in purchasing power. The purchasing power of the average Chinese or Taiwanese person is still way below the average American. That is precisely the reason why big companies like Apple cannot ignore their American operations.
Although there are tremendous growth opportunities in emerging Asian markets, the vast majority of the purchasing power still remains in the developed Western world and Japan. Apple products are simply too expensive to be acceptable on a very large scale in the emerging Asian markets. The good sales figures in China are simply the result of the buying spree by the Chinese elite. As soon as that segment gets saturated -- and, in my opinion, it will very quickly -- the sales growth in China might take a considerable hit. If China starts failing to compensate for weakness in the American market, Apple's sales projections might be in serious doubt.
4. There are some cracks emerging in the Chinese economy. While China is usually applauded for keeping up its impressive growth rate after the financial crisis, there are some recent signs that it might have cooked the books a little to accomplish that growth. If that is indeed the case, the Chinese economy might suffer considerably, as much of the growth comes from economically unfeasible infrastructure investments. Once the illusionary financing for those investments disappears, Chinese economy might find itself in a tailspin. Any such event would also surely reverberate through other emerging Asian countries that depend on China for their exports.
Let me correct a possible misunderstanding about how this applies to Apple. China is still a great market to expand into, even if it goes through some difficulties. However, because of the fact that there might be some illusionary effects to the purchasing power of the Chinese elite, it is too risky for Apple to depend solely on China and other emerging Asian markets for its growth. Apple should take care of its problems in its home market expeditiously rather than concentrating all its efforts on Asia.
5. Asian emerging markets are not stable markets, and the fluctuations in performance over there might aggravate institutional Apple investors relying on stability. Many investors are overly exposed to Apple's stock, ignoring the risks of concentration. That has not been a problem in the recent past because Apple has shown remarkable consistency in its success. However, Asian markets are economically volatile markets. Their economic performance fluctuates by a wider margin compared to the US. If Apple relies too much on Asia for a large percentage of its sales, such volatility will effectively show itself in Apple's fundamentals. In that case, investors would not be able to have such concentrated positions in Apple since its stock performance would become volatile and stock-specific risks would increase.
If you have your own interesting opinions about Apple's prospects in Asia, go ahead and comment below. I hope this article stirs up a good discussion about how Apple's performance in Asia might effect the company in the medium term.