Morgan Stanley: Three weeks before Apple gets slapped with new tariffs

In a worst case scenario analyst Katy Huberty sees a 4% hit to FY20 revenue, a 60bps hit to gross margins and a 10% hit to EPS.

From a note to clients that landed on my desktop Friday:

On Thursday, August 1st, the US Administration announced it plans to impose a 10% tariff on the remaining ~$300B of goods that China exports to the US (Proposed List 4), starting on September 1st. This list includes not only items like the iPad and Mac but also the iPhone, which all together comprise ~75% of Apple’s FY19-to-date revenue. Investors are asking us how Apple could mitigate this round of tariffs, what a worst-case impact to our estimates could be, and where we see a near-term floor in the stock.

Our view: The threat of tariffs on products manufactured in China and exported to the US is not new for Apple, and has been an overhang on the broader tech hardware subsector since April 2018 when the Office of the US Trade Representative first proposed tariffs on $34B of Chinese exports to the US. To date, our coverage group has seen a limited cost impact from the tariffs put in place on the $250B of goods exported to the US from China. Apple saw both the Apple Watch and AirPods removed from these lists while both HPQ and HPE have actually raised EPS guidance in the last 12 months despite tariffs on certain components used in desktops and/or storage and networking equipment shipped from China. And while the bulk of Apple’s most significant products manufactured and shipped from China to the US – most notably the iPhone, iPad and Mac – will now be subject to a 10% tax starting September 1st, Apple has had 16 months to work with supply chain partners and contract manufacturers on how to mitigate the tariff cost, and we expect Apple to take multiple steps to limit the tariff impact…

That said, if we make the more extreme assumption that Apple doesn’t implement supply chain mitigation efforts and either 1) absorbs the entire cost of the 10% tariffs or 2) decides to raise prices in the US to offset the tariff cost, we see a worst case scenario of 8-10% downside to our FY20 EPS of $12.68, as seen in Exhibit 1. In the most extreme 10% downside case we assume that Apple raises the price of the iPhone, iPad and Mac by 5% in the US, sees lower gross margins from absorbing part of the tariff cost, and sees shipments to China and the US each fall by at least 10% Y/Y in FY20, with iPhone shipments to China declining even more precipitously due to more nationalistic behavior (all assumptions can be found in Exhibit 2). In this scenario, we’d expect a 4% hit to our current FY20 revenue, a 60bps hit to gross margins, a 120bps hit to operating margins, and a 10% hit to FY20 EPS, also assuming Apple slows buybacks to $10B/quarter, lower than our current $20B/quarter estimate (Exhibit 1).

Click to enlarge.

My take: Tim Cook has three weeks to work his magic.

4 Comments

  1. Gregg Thurman said:

    “My take: Tim Cook has three weeks to work his magic.“

    Really?

    I think Apple was preparing for this POSSIBILITY, in the normal course of business planning (known as Plan B), long before Trump became President.

    I would expect nothing less from a corporate culture that plans 5+ years into the future.

    Huberty has done a commendable job calculating worst case, I just don’t see worst case happening and quite likely is already factored into Apple’s guidance.

    3
    August 9, 2019
  2. Aaron Belich said:

    WTF. Agreeing with Greg, but isn’t all this talk of tarrifs the reason AAPL isn’t $300/share!?

    0
    August 9, 2019
    • Gregg Thurman said:

      There’s no accounting for irrational fear on WS.

      0
      August 9, 2019

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