Today Apple is announcing their new product lineup at a 1pm launch event – 3 new phones are expected. Analyst expectations around the new device launches are ratcheting up, with some increasing price targets. This is despite developments on the tariff front that are looking more threatening to Apple. Last week the White House took comments on the latest round of impending tariffs (up to 25% tariffs on $200 billion in Chinese goods). This would be on top the $50B of Chinese exports already hit with 25% duties (which didn’t effect Apple’s products). Apple submitted a comment letter indicating the $200B round of tariffs would affect the Apple Watch, AirPods, MacMini and Apple Pencil. These items account for <5% of Apple’s revenue. So, not a big hit yet. In the letter Apple said, “tariffs increase the cost of our U.S. operations, divert our resources and disadvantage Apple compared to foreign competitors.” The letter also reiterated a lot of what Tim Cook said on Apple’s last earnings call – essentially that tariffs are a tax on the consumer and that they can have broad unintended economic consequences.
Next Trump threatened another $267B in tariffs and suggested Apple should move their manufacturing to the US. In June, the Trump administration said they would not impose tariffs on iPhones, but this next $267B suggests otherwise as that basically implies a duty on all goods imported from China. This could be used to influence Apple to move some manufacturing to the US. Most of Apple’s assembly occurs in China (only about 5% of Apple’s manufacturing takes place in the US) and to shift this would take a lot of money and time. Labor supply in the US would also be a limiting factor. Trump hinted at tax incentives that would help offset the cost of doing this. If more assembly moved to the US, it seems likely that most of the higher labor costs would be passed on to consumers via higher prices. Most estimate price increases in the 15-20% range to offset higher labor. While Apple has a lot of buyer power, their suppliers generally operate on thin margins making it more difficult to push some of this higher cost burden to them. This is illustrated by the chart below from The Economist of Apple’s 42 biggest suppliers (representing 75% of Apple supplier gross profits). Apple and the chip suppliers occupy the high value added, high margin portion of this value chain and command 90% of the profit pool. Interestingly, this disparity also illustrates potential risks that come with their complex multinational supply chain. That profit concentration could lead to structurally weaker participants that may have a hard time weathering these trade tensions. The not Apple and not chip (i.e. not US) portion of production has most of the employees and requires lots of capital for PP&E and inventory, but they capture only a small sliver of the profits. Because of this, there may be some financially weaker players in the supply chain. Combining low margins and capital intensity (likely have debt to service) could put some suppliers at risk if costs rise or business from Apple slows as trade issues get sorted out.
Sarah Kanwal
Equity Analyst, Director
Direct: 617.226.0022
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square, Suite 500
Boston, MA 02109