* Apple's iPhone is in the crossfire of the trade dispute with China
* Apple's share price, despite the imprimatur of Warren Buffett and the recent fall from grace, may still be vulnerable
In this morning's opening missive, I remarked that the Apple complex of suppliers is a factor pressuring the overall markets recently.
Relatedly, two weeks ago (on November 27th) I issued a negative analysis of the company, "Apple's Outlook Grows Murky" - I strongly stand with that view:
Surprise #9 The China/U.S. Rift Intensifies as Trump's Anger Shifts Towards That Region:
"The trade war with China goes into full effect with 25% tariffs. Walmart (WMT) is adversely impacted and its shares fall by 20% from the recent highs. The Chinese retaliate against major American brands like Apple. ("Peak Apple" actually happens and its shares fall below $125/share).
Peter Navarro resigns.
A major cyberattack against the U.S. financial system, who's source is initially not diagnosed, is ultimately reportedly to have been delivered by China. The U.S. enters a cold war with China that resembles the emergence of the cold war with Russia in 1948 - it becomes clear it will be lengthy, nasty and unfriendly to the trajectory of worldwide economic growth."
- Kass Diary, "15 Surprises for 2019"
While I have had some brief periods of optimism about Apple Inc. (AAPL) in which I took a trading long in the shares, beginning back in 2012 when the company faced margin degradation and the shares dropped by 35%, I have been mostly negative (and wrong) on Apple. Back late last year, in "How I Was Wrong on Apple but Lived to Invest Another Day," I chronicled my generally poor timing and observed that the appropriate investing course was, as Jim Cramer puts it, to be long and not to trade Apple.
It is now time, after the recent fall, to consider the current risks still associated with holding the company's shares:
* The iPhone is a mature product and the high-end smartphone market is saturated, with most of the unit growth a function of the replacement cycle. In support of this view is the company's decision to stop disclosing iPad and iPhone unit shipments.
* Since the introduction of the iPhone X, Apple has been raising prices. ASPs (average selling prices) in the most recent reporting period buoyed sales (up 24%) even though unit sales were flat. This briefly buoyed Apple's shares, but it is more likely representative of "Peak Apple (Margins)." (Note: Beginning in late 2017 I began to get concerned about demand elasticity from high-priced iPhones.)
* With a lack of significant product innovation, those higher iPhone prices will likely elongate the replacement cycle from slightly under two years to as much as four years.
* In order to grow, the company has monetized its installed base of Apple products by selling services (apps, music, movies, etc.), sales of which reached $10 billion in the most recent quarter. But Apple's digital store has had its share of failures. An example is Apple's email product (MobileMe) and its iCloud data-storage service, which respectively lost their relevancy to Alphabet Inc.'s (GOOGL) Gmail and to Google Drive and DropBox Inc. (DBX) . Apple Maps only exists as it is a default service on the iPhone. Meanwhile, Apple competes versus Amazon.com, Inc. (AMZN) in streaming music and movies. Its closed systems don't allow Apple music to work on speakers furnished by Amazon and Google. Finally, there is Siri, the quality of which is materially lower than both Alphabet's Hey Google and Amazon's Alexa, which have opened their digital voice assistants to other developers.
* Apple is a products company (two-thirds of its sales come from the "closed" iPhone) that has developed complex and expensive operating devices that evolve over time. By contrast, services (software) require more prompt revisions and almost continual improvements and usually are inexpensive, as much of services is commoditized. Consider that Apple speakers will not play Spotify (SPOT) , one of the most popular music services and a competitor to Apple. So, in a sense, Apple in the services arena is fighting with one arm tied behind its back in order to protect the iPhone (hat tip to my contrarian friend, Vitaliy Katsenelson).
* There is no apparent new category that lies ahead in the relatively near future that will move Apple's sales/profits needle.
* Should Apple's installed base growth ease in rate-of-change terms, the valuation argument that Apple should be valued as a consumer packaged goods company -- something I have consistently rejected -- versus a lesser-valued hardware company may prove to be faulty.
Given Apple's current size, the maturity of the iPhone market (iPhone unit shipment growth is slowing) and legitimate questions as to whether the service strategy will be successful as the installed base slows down, a large and new product offering -- more than, say, Apple Watch sales, which is nothing more than a rounding error -- is urgently needed to support the share price and its elevated valuation based on historic comparisons and based on the history of other hardware companies. But, there is no apparent large opportunity that would have any material and incremental impact on Apple; the company's past successes and size are impediments to moving the needle.
The iPhone, priced at $800 per unit, which is high compared to other smartphones with similar functionality, poses a fundamental risk of accelerated commoditization and lower margins. And the likelihood of a longer replacement cycle, as we already have seen at the high end of the market, provides a hurdle to future sales and profit growth on Apple's already large sales base.
Then there is China, where almost 25% of Apple's Chinese business may be subject to the imposition of tariffs. And, even more significantly, elevated disputes with China could dangerously disrupt the company's supply chain, which has swung over to that region over the last decade.
Stated simply, Apple's iPhone may be in the crossfire of the trade dispute with China and its share price, despite the imprimatur of Warren Buffett and the recent fall from grace, may still be vulnerable.
(This commentary originally appeared on Real Money Pro at 10:15 a.m. ET on Dec. 10. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and others.)