China Trade War Accelerates Importance Of India To Apple

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About: Apple Inc. (AAPL)
by: Nick Cox
Summary

There has been a recent intensifying of contacts between Apple and Indian authorities.

An apparent long-term trade war on China initiated by the U.S. administration has made the matter more urgent.

There are non-confirmed reports that major iPhone manufacturing will ramp up in India shortly.

There's a strong probability that Apple is planning manufacturing elsewhere in Asia apart from China and India.

The problems Apple (NASDAQ:AAPL) faces in China are well covered. The company is particularly severely affected both for its sales in China and for its manufacturing there.

This scenario has been a long time coming. In my article in May last year I speculated that Tim Cook needed to move more quickly in India. The reliance on China was getting too great with a protectionist president and advisers who see China as a threat to the US.

No doubt Tim Cook has been aware of the risks. Starting new initiatives in India is tough, not least because of cloying bureaucracy and rampant corruption. There's also a difficult and complex "Make in India" policy. However, there are signs that activity in India could pick up rapidly for Apple now. The initial impact would be on manufacturing rather than sales. Important announcements may be pending. If this comes about it would be a bullish signal for the stock price.

Asia

My article in April centered around the Q1 2018 results of Apple. Though found disappointing by some analysts, they showed Apple's continued strong growth around Asia. 32% of new sales are from Asia. I first wrote about the importance of Asia, and in particular China, in 2014. Then a lot of responses from readers was that it was unrealistic to think expensive Apple products could sell in countries like China. Now all the talk is that Apple is over-reliant on sales in China!

There's likely to be an increasing consumer boycott of Apple products in China as a reaction to the Trump Administration's attack on the country and on Huawei.

Apple has other excellent markets in Asia, especially in Japan where it has the highest market share anywhere in the world. As per the 10-Q from Apple, net sales in the six months to end-March were as follows:

Greater China = US$30.9 billion.

Japan = US$12.7 billion.

Rest of Asia Pacific = US$10.8 billion.

With or without Chinese growth, Asia will continue to gain in importance for the company long term. My article here detailed some of the huge population growth figures and economic growth figures from Asia. In particular one can see the rise of an affluent and aspiring middle class around the continent. In the short term India is not going to make much difference in net sales numbers. Chinese sales seem certain to drop off in the short term because of trade war concerns.

At the Q2 2019 earnings conference call, Tim Cook was bullish about Asia in general. He was unusually guarded in his comments about how successful they were in India. He stated:

"We've made some adjustments in India and we've seen preliminary better results there."

In the short term, however, the stock price would benefit greatly from hearing some good news for Apple from India. The country will be in focus for both manufacturing and for sales.

India.

The template for India long term is fairly similar to what Apple achieved so successfully in China. They need manufacturing for the local (and now for the overseas) market. They need to build up the iPhone base and get the full stickiness of the Apple ecosystem with laptops, iPads, wearables and music. They need to build up core developers for the local market. They need to set up a viable retail network.

The strength of the Apple ecosystem around Asia has grown from the volume of its iPhone installed base. This is not that large in India. It explains why, for instance, the music service of Spotify (NASDAQ:SPOT) has been making inroads into the Apple Music business this year.

The just completed long-running Indian general election has not helped decision making in India. That's now finally out of the way and may allow for some active decision making. Government regulations and bureaucracy are a constant problem in the country. Apple, along with other foreign companies, for instance recently got embroiled in a dispute with the government over import permits and e-waste which threatened to hold up imports. Recent indications though are more promising.

Last year Apple was making the old Apple SE phone for the local market. Its partner Wistron (OTC:OTC:WICOF) also was manufacturing the 6S at their factory in Bengalaru. Sales were not very exciting. This was against the competition of 500 million feature phones per annum from domestic manufacturers. Smartphone competition was headed by Samsung (OTC:OTC:SSNLF) and brands such as One Plus, Xiaomi (NASDAQOTH:OTCPK:XIACF) and Oppo from China. India is adding huge numbers of new Internet connections every month. Most of these are mobile connections. It's already the world's second largest mobile phone market, behind China.

Recent reports indicate that Apple has been doing quite a bit of price- cutting in the Indian market. This includes subscription services for services such as Apple Music as well as for hardware products such as the iPhone XR. Deals offering generous down payments and cash-back plans have not been especially successful. The strength of the US dollar against the Indian currency has not helped.

The price cutting does not appear to have had much positive effect so far. According to a recent report from Counterpoint, Apple's share of the smartphone market has actually fallen this year, to under 2%. They calculated that Xiaomi were the market leader with 27% and Samsung with 22%. Apple's target of US$5 billion in sales by 2020 seems far away. There's a substantial grey market for iPhones imported from countries such as Singapore. Those numbers are hard to compute accurately.

The company has started a new advertising blitz for the iPhone 6S, as below:

appleinsider

This plays on the government slogan of "Make in India."

It's believed that Wistron has ramped up production of not just the iPhone SE and 6S, but also of the iPhone 7. It's thought that this may presage the end of the SE and 6S models in the country with those models being replaced by the iPhone 7. Some reports have stated that Wistron was investing large sums at its Narasapura plant for producing new Apple items. As is often the case in India, these reports have been denied by others, so it is not easy to get a clear picture.

Apple has found it difficult to get the retail structure right in India. There has been a somewhat regular and unsettling changing of retail partners. Elsewhere in Asia Apple stores have been a tremendous success. In India they are less easy to set up. It's thought that Apple has been negotiating for over a year with the Indian government on this.

Recent press reports suggest the company is close to tying down an arrangement with the Indian government to open retail flagship stores in the country. The first of these are expected to be in Mumbai. The official regulation states that a single-brand retailer in India needs to have local sourcing of at least 30% of components. The ramping up of manufacturing by Apple in India would tie in with this possibility of a retail initiative at last.

Unconfirmed reports state that Chinese competitor Xiaomi (XI) plans to open 10,000 stores in the country. That gives an indication of how manufacturers view retail potential in the country.

At the Q2 earnings call, Tim Cook stated:

"We would like to place retail stores there. And we are working with the government to seek approval to do that. And so we plan on going in there with sort of all our might."

Last year also saw a lot of changes in Apple's senior management around the country.

It seems more likely that substantial manufacturing of new phones will come through Foxconn (OTC:OTC:FXCOF) rather than Wistron. Sources indicate that Apple's biggest contract manufacturing partner is trialing manufacture of the iPhone X in India, and that Apple is pre-planning this autumn's new iPhone range to be at least partially made in India. It's reported that Foxconn has been investing quite substantial sums (between US$250 million and US$300 million) in its manufacturing facilities in India this year. The Xr is said to be under active testing at its Chennai plant. Apple recently increased sales of the Xr quite substantially by cutting prices by 20%. This of course was a serious margin hit on the imported product.

Concerns previously expressed by Foxconn include less skilled labor than that found in China, and poor Indian transport infrastructure. They had been mulling over producing in bulk in Vietnam as one possible alternative.

Comments by a senior Foxconn executive seemed to indicate that they might indeed be producing the new range of 2019 Apple phones in India on a mass scale. Foxconn currently have plants in India producing phones for Xiaomi and Nokia (NYSE:NOK). A new plant could be developed specifically for mass production of Apple's new phones. That would indicate these would not just be for the Indian market but for the world market. This could be a significant boost to sentiment around Apple if the Cupertino company were to confirm it. Such an announcement would have a positive impact on the stock price.

It's a lingering question whether the local market itself is ready for the expensive high-end new models. Local manufacture does at least cut out the high import duties. There has been further talk of a new luxury tax for imported items of a certain value. So mass production by Foxconn would almost certainly be for the world market.

Elsewhere in Asia

It's possible that Apple has major manufacturing expansion plans for other countries in Asia. The network of the supply chain does range across various Asian countries. Presumably Tim Cook would have to move diplomatically if he were to shift manufacturing from China while still giving his backing to Apple's Chinese operations.

Cook is well known for his diplomacy, his logistics skills and his lobbying skills. Some have suggested that he has however put too many eggs in one basket with regard to China. It does mean though that China in turn is loathe to move too strongly against Apple. It's thought that the company is worth US$24 billion to the Chinese economy and that it directly and indirectly is responsible for 4 million employees.

Reports have circulated that Taiwanese contract manufacturer Pegatron was committing between US$695 million and US$1 billion to new manufacturing plans for Apple in Indonesia. These have not been confirmed. There must be some doubt as to availability of sufficient skilled labor and infrastructure in that country.

It's interesting that Apple's arch rival Samsung (OTC:OTC:SSNLF) has been suffering similar problems in China. Their market share has collapsed. This is partly because of strong Chinese competition. It's also though due to anti-South Korean sentiment in China. This is similar to the anti-US sentiment there. It's thought they have been ramping up production elsewhere in Asia.

For all the companies in the mobile phone business, there's a lot of back-up technical expertise and infrastructure around Asia. This is one thing that makes suggestions that companies like Apple bring back production to the US quite untenable. There was a much publicized deal for Foxconn to start producing on a large scale in Wisconsin. Recent reports indicate this is not going smoothly, and that indeed Foxconn have been switching some jobs from the US to Mexico.

A senior Foxconn executive in early June was quoted as saying that the company could meet its Apple commitments by manufacturing elsewhere in Asia apart from China. India and Vietnam were specifically mentioned.

Conclusion

The challenge for Apple in India is a new imperative. Tim Cook's recent comments have indicated that India is a somewhat slow-moving, long-term goal for them. Cook first visited India and met Prime Minister Modi back in May 2016. The need to build the domestic market from the bottom up is still there as a long-term target.

On the sales side, developments in the trade war with China have changed imperatives somewhat. Substantial consumer retail sales would help Apple as Chinese numbers may well decline. It will take time though.

On the manufacturing side, it may be easier to switch manufacturing to India than to build up sales there. Apple may want to convert India into a major manufacturing hub in the short to medium term. However it does appear that they do have alternatives, especially through their main manufacturing partner, Foxconn.

At some stage quite soon, swirling rumors are likely to translate into official announcements. This would give a boost to the Apple stock price amidst market concern about its over reliance on China.

Disclosure: I am/we are long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.