A Surprise Common Cents on January 3, 2019

The calendar may have turned a page, but it sure feels like déjà vu all over again.

If you read financial and business news, you might have seen Apple issued a press release last night warning the most recent quarter’s earnings might not be as robust as initially thought. The company’s claims this is due, almost exclusively, to slower iPhone sales in ‘Greater China’ due to tariff woes and a stronger US dollar. From what I read in the statement, it seems the remainder of the product mix is working just fine, good even. However, iPhones are the company’s primary business line, and China is a major market.

Not surprisingly, the markets didn’t like the warning. So much so, the first trades on the stock this morning were about $13.50 less than where it closed yesterday afternoon. For all intents and purposes, it hasn’t moved that much since the first couple of minutes of trading. However, Apple has been an anchor on the markets this morning, but what are the long-term prospects?

Do you want the growth story or the value story? As for the former, it is pretty hard to argue the company will see the same levels of global growth over the next several years as it has enjoyed over the last decade or so. While the estimates of smartphone users around the world vary pretty wildly, for whatever reason, it is safe to say it is a maturing industry, although not quite completely mature globally. On top of that, smartphones aren’t cheap, let alone Apple’s, and the biggest opportunities for ‘penetration’ are in poorer, densely populated countries like Bangladesh, Pakistan, Nigeria, India, etc.

So-called Greater China (PRC, Hong Kong, Macau, and Taiwan)? Some estimates have adult smartphone penetration already hovering around 90% or so. Almost by definition, iPhone growth there, as in other similarly penetrated wealthy markets, would have to slow.

Then there is the issue of tariffs and currencies, and all that jazz.

Here are the nuts & bolts. China can and does manipulate its currency relative to the US dollar in order to bolster domestic industries and exports. On March 22, 2018, the Administration first instructed the United States Trade Representative to apply tariffs on $50 billion worth of Chinese-made goods. On that day, the spot price for the Chinese renminbi was ¥6.3375 to the dollar. As the trade war continued, the renminbi fell to as low as ¥6.9758 to $1 on Halloween. It closed the year at ¥6.8785.

That means prior to the announcement of the first round of tariffs, ¥1 purchased $0.1578. At its worse, ¥1 brought $0.1434, and closed the year at $0.1454. That works out to be a 7.85% reduction in the purchasing power of the renminbi relative to the dollar. If nothing else, Apple is ‘translating’ its profits in the PRC back into fewer dollars, up to 7.85% fewer. So, currency changes have major impacts on multinational balance sheets. As for demand, China is a competitive economy which a number of different smartphone players. Throw in a higher end product potentially selling at a higher price point due to some currency fluctuations, let alone a potential anti-US bias, and, you know, revenue was probably going to be a little disappointing in the PRC….no matter what the company did.

That is the bad news.

The good news is, if you want to find silver linings in dark clouds, and I do, is Apple is an operating machine, with high profit margins and a lot of cash. Further, the company understands its reliance on iPhone unit sales, and is making strides in diversifying its product mix. After all, there are now something like 700 million+ now on the iPhone platform. These people buy apps, listen to music, are subject to advertising, buy chargers, headphones, and all sorts of other peripherals. Then, lest we forget, Apple still makes computers and tablets, let alone enterprise solutions for business and individuals (if you are so inclined). In short, while iPhone unit sales in Greater China are an important part of Apple’s product mix, there is so much more to the company than, well, iPhone unit sales in Greater China.

So, in a lot of ways, currency fluctuations aside, Apple is a money generating engine. However, throw in a weaker US currency at some point in the future and, voila, all is right with the world. I can’t stress how much a strong dollar negatively impacts US multinational corporations.

Then, there is the question of valuation. After this morning’s selloff, Apple is currently selling at an estimated Price/Earnings multiple of around 12x. The S&P 500 is currently trading around a 16-17x multiple. As such, a vast, well run, moola generating behemoth with quite possibly the best brand in the world is currently trading at a decent discount to the broad market. IF you don’t believe me, go ahead and read the remainder of Tim Cook’s message to the world. If you don’t want to do so, let me sum it up: “we aren’t going to make as much money as we thought we would, thanks largely to the Chinese, but we are still going to make a lot, a whole lot, because the rest of the company is doing fine.”

In the end, we maintain Apple remains a good core holding at this time, and are not looking to sell it over a disappointing, but still financially strong (or proves to be), quarter. There remains much to like.

…as for the other millstone around the markets’ neck today.

This morning the Institute for Supply Management (ISM) issued its monthly Manufacturing Report On Business. I won’t mince words: it was the weakest release since November 2016, and came in several points below analysts’ expectations (54.1 vs. 57.5). Perhaps a little more troublesome was/is one of the line items, New Orders, fell sharply from 62.1 to 51.1. The financial news media has had a field day with this one.

Since these numbers are undoubtedly so much ‘Greek’ to a lot of people, let me give you some comments straight from ISM:

“Manufacturing expanded in December, as the PMI® registered 54.1 percent, a decrease of 5.2 percentage points from the November reading of 59.3 percent. “This indicates growth in manufacturing for the 28th consecutive month. The PMI® recorded a substantial softening in December and retreated to a level not seen since November 2016, when it registered 53.4 percent,” says Fiore. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI® above 43.2 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the December PMI® indicates growth for the 116th consecutive month in the overall economy and the 28th straight month of growth in the manufacturing sector. “The past relationship between the PMI® and the overall economy indicates that the PMI® for December (54.1 percent) corresponds to a 3.4-percent increase in real gross domestic product (GDP) on an annualized basis.

Diffusion indexes have the properties of leading indicators and are convenient summary measures showing the prevailing direction of change and the scope of change. A PMI® reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally declining. A PMI® above 43.2 percent, over a period of time, indicates that the overall economy, or gross domestic product (GDP), is generally expanding; below 43.2 percent, it is generally declining. The distance from 50 percent or 43.2 percent is indicative of the strength of the expansion or decline. ”

I added the highlights and underlines.

To be sure, this wasn’t what the market wanted. However, it was far from disastrous, far from it. If you want disastrous, and I mean what the heck type of stuff (if not stronger), please let me refer you to the October 2008 ISM report and the regional Philadelphia Fed Survey for the same month. THOSE were bad, and I mean mind-numbingly awful. This morning’s number? It was more of a gee whiz than anything else. After all, everything in the report you want to see OVER 50 WAS OVER 50. Everything you want to see UNDER 50, well, WAS.

Don’t get me wrong: this was not a great report, but it wasn’t demonstrably awful. It was akin to getting a top sirloin when you wanted a ribeye. Hey, it ain’t potted meat or Vienna sausages, far from it.

Under normal circumstances, this type of ‘miss’ might engender a 150-point selloff in the Dow Industrials Average, maybe. It just came at a really bad time, on the heels of Apple’s news. As a result, it has taken on a more sinister form or tone: what if the US is already in a recession even though the economic data says we are in an expansion? What if? Oh, the anxiety.

That last word pretty much sums it up: anxiety. Investors have it by the bushel, to their own detriment.

Let me sum everything up, and I mean wrap it all together in a nice little package, with this: the news this morning isn’t what any of us would have ideally wanted, but it wasn’t anywhere near as bad as ‘we’ are making it out to be. Far from it. IF we get another day or two like this one, we are going to start deploying some of that cash we raised during the month of December.

Have a great day

John Norris


This report does not constitute an offer to sell or a solicitation of an offer to buy or sell and securities. The public information contained in this report was obtained from sources and vendors deemed to be reliable, but it is not represented to be complete and its accuracy is not guaranteed.

The opinions expressed within this report are those of the investment committee of Oakworth Capital Bank as of the date of publication. They are subject to change without notice, and do not necessarily reflect the views of Oakworth Capital Bank, its directors, shareholders, and employees.