Worsening trade tensions are tamping down the expectations for the trajectory of Apple Inc.'s (AAPL) stock going into 2019.
Shares of the Cupertino, California-based company have fallen more than 25% so far in the fourth quarter and were down in pre-market hours on Monday, leaving Apple firmly beneath Microsoft Corp. (MSFT) in the battle for the title of the most valuable company in the world.
Despite the shrinking of Apple's forward price-to-earnings (P/E) multiple to less than 13, Apple's shares have not become more attractive to those covering the stock.
"While the stock's trading multiple has compressed from recent highs, it remains in the middle of the five-year range," KeyBanc analyst Andy Hargreaves wrote on Sunday. "Our expectation for multiyear deceleration, and the risks of deteriorating U.S./China relations and increased antitrust scrutiny around the App Store, suggest little to drive multiple expansion from these levels."
Hargreaves maintained a "Sector Weight" rating on Apple amid the constraints on multiple expansion at Apple, which is a holding of Jim Cramer's Action Alerts PLUS charitable trust.
Big Trouble in Little China
Top of mind for investors is the whipsaw relationship between the United States and China.
Early last week following the G-20 summit in Argentina, dovish trade tweets from the Oval Office took many stocks higher. By week's end, the arrest of Huawei Technology Co. CFO Meng Wanzhou for allegedly helping her company dodge U.S. trade sanction on Iran quickly soured any optimism on the relationship.
As an illustration of the impact of the mercurial relationship, Apple shares rose 3.5% on Dec. 3 as the trade tensions appeared to be easing, only to fall by nearly 10% the rest of the week.
The heightened tension only serves to exacerbate concerns about underlying data trends in Apple's second-largest market.
"China smartphone market [is] responsible for recent weak iPhone data points," Morgan Stanley analyst Katy Huberty wrote in a research report on iPhone demand. "Our recent meetings in Asia highlight a weakening China smartphone market, especially at the high-end where suppliers have seen order cuts across most vendors."
Huberty largely blamed the weakening market on Chinese replacement cycles for phones, which have begun to lengthen due to improved phone quality across brands and, as a result, have stunted Apple's profit potential in the nation.
"China is following in the footsteps of the U.S. with replacement cycles lengthening after a structurally shorter cycle over the last decade," Huberty said. "Our analysis of shipment data suggests that for the broader China smartphone market, replacement cycles have lengthened materially in the past two years, but for Apple, the replacement cycle lengthening in China has been more pronounced, with implied replacement even longer than the market over the past year."
Huberty also said Chinese vendors, such as the aforementioned Huawei, are beginning to catch up in terms of market share based on improving quality of phones at a much lower price point than Apple.
Patriotic buying in China spurred by trade tensions and the arrest of the Huawei CFO could create further issues for Apple.
Seen a lot of these on Chinese social media this weekend. There are so many different conspiracy theories about the arrest, as if Alex Jones had started daily production of Mandarin programs.
Expect major slump in sales for AAPL, GM in China. https://t.co/HexMaG7iVk— Barton (@Barton_options) December 10, 2018
To be sure, Apple does maintain other revenue streams, namely in the burgeoning wearables business and in services.
The company's AirPods in particular have become a major holiday hit for tech-minded gift givers, with analysts highlighting the upside potential from a wearables segment that can tap into the billions of consumers who already own iPhones. AirPod production is expected to double in 2019 on the back of increased demand.
The same is true of the services segment, which has shown an ability to grow revenue despite slowing iPhone sales.
Huberty has retained her "Overweight" rating for Apple stock on the perception of a still-available upside. However, with nearly 20% of Apple's total revenue tied to China, the upside for Apple shares is becoming more clouded and price targets are coming down on Wall Street. Huberty is among the analysts reducing their targets.
"We lower 2019 iPhone units after Asia meetings highlight lengthening replacement cycle and churn in China," Huberty wrote. "Lower estimates and peer multiples drive price target to $236 from $253."