Could Apple shares get caught in the US-China crossfire?

With a YTD loss of just under 7%, Apple is not only the best performing FAANG but also among the best performing tech shares this year. However, the company risks getting caught in the US-China tensions.

Apple (NYSE: AAPL) reported its fiscal third quarter 2022 earnings last month. Its revenues rose 2% YoY and reached $83 billion. The revenues were slightly ahead of what analysts were expecting and a new June quarter record for the iPhone maker. Importantly, its iPhone revenues rose 3% YoY to $40.67 billion and defied all the slowdown noise. The growth in services revenues did taper down and fell to 12% in the quarter.

Apple’s second-quarter earnings were better than expected

While it is still higher than the overall revenue growth, markets were used to much higher revenue growth from the business. Apple’s EPS also fell 8% YoY to $1.20 in the quarter but was ahead of the $1.16 that analysts were expecting.

Commenting on the guidance, the company said, “Overall, we believe our year-over-year revenue growth will accelerate during the September quarter compared to the June quarter despite approximately 600 basis points of negative year-over-year impact from foreign exchange.”

Markets sent Apple shares higher after the earnings beat. Among FAANG constituents only Meta Platforms fell after releasing the earnings as the Facebook parent posted its first revenue decline since it went public. Along with a general slowdown in ad spending, Apple’s iPhone privacy rules are also taking a toll on Facebook’s revenues.

Analysts see ad revenues as a key driver for Apple

Meanwhile, Needham’s Laura Martin sees ad revenues as the next driver of Apple’s revenues. She wrote, “We believe advertising could be a meaningful upside driver for AAPL’s Services revenues and gross profit, especially based on AMZN’s success in growing its advertising business to $37B in 2022E, up from $4B five years ago.”

Martin added, “We note that advertising revs typically have 70%-80% profit margins, so AAPL’s EPS should grow faster than revs, as its advertising rev grows.” Notably, one of the reasons markets have awarded higher multiples to Apple shares is the growing share of services revenues. The company is not only seen as a gadget maker but also a software and services company. Typically, software companies trade at much higher multiples as compared to hardware companies.

Apple’s trading multiples

While Apple’s trading multiples have come down from the recent highs, they are still much higher than the historical average. Also, the multiple contraction is not limited to Apple alone and most tech shares have seen a derating amid slowing growth and rising interest rates.

Alluding to the iPhone privacy changes, Martin said, “AAPL is a Walled Garden with best-in-class user data, at the same time it is lowering the tracking and transparency data available to other companies,” which would increase the tech giant’s pricing power.”

The installed base of Apple devices hit an all-time high in the June quarter across major product categories as well as geographies. The base is a captive audience for Apple to cross-sell other products. The company is looking to increase its TAM (total addressable market). In the short term, it is expected to launch AR/VR sets while in the long term, the company is reportedly betting on electric and autonomous cars. Apple had 825 million paid subscribers across devices in the June quarter and has added 165 million subscribers over the last year, which is a significant number.

US-China tensions are a risk for Apple investors

Growing US-China tensions are a potential risk for Apple investors. US-China relations which were anyways at the lowest level in decades have deteriorated further after Nancy Pelosi visited Taiwan. For Apple, China is a major market and also a sourcing hub. In the past also, the company has faced boycott calls in China. However, it downplayed the risks and said that it did not have a material impact on sales.

Apple is anyways battling a severe slowdown in China where the intermittent lockdowns have taken a toll on sales. Business Insider reported that Apple has cautioned its suppliers against using “Made in Taiwan” as it would only flare up the troubles.

While Apple has been trying to diversify its supplier base after the US-China trade war, the company still heavily relies on Chinese suppliers.

Warren Buffett loves Apple shares

Apple is the largest holding of Berkshire Hathaway and chairman Warren Buffett regrets selling some of the shares since 2019. The Oracle of Omaha sees Apple as a consumer products company and has also been supportive of its buybacks. Thanks to these buybacks, Berkshire Hathaway’s stake in the company has risen despite selling billions of dollars worth of shares.

In the first quarter of 2022, Buffett bought Apple shares for the first time since 2018. The purchase was significant as the Oracle of Omaha did not buy Apple shares even when they crashed by over 30% in Q4 2018 amid the US-China trade war.

Apple’s cash pile has come down

He then said that he would buy the shares at a lower price. However, Apple shares continued to soar since then. On the first trading day of 2022 itself, Apple’s market cap hit $3 trillion, and it became the first company ever to achieve that milestone. It was also the first US company to hit a market cap of $1 and $2 trillion.

Apple is a cash flow engine and the company has been using the cash flows for share repurchases to drive the EPS higher. The same trend is expected to continue in 2022 as the company has enhanced its share buyback program even further. It returned $28 billion to stockholders in the June quarter and had net cash of $60 billion. The company intends to reach a cash-neutral position which would mean more buybacks.

The company might also look at acquisitions and its CEO Tim Cook has not denied the possibility of a strategic acquisition.