Apple Inc (AAPL, Financial) has lost almost $200 billion in market value in the last couple of trading sessions with the company coming under pressure from the Chinese government. Chinese policymakers have reportedly informed government agencies to stop using iPhones, and this decision has dampened investor sentiment toward the tech giant. Investors fear that this decision may eventually lead to a nationwide ban on iPhones. According to Wedbush Securities analyst Dan Ives, these fears are overblown and the recent decision by China will only affect around 500,000 iPhones out of the 45 million iPhones Apple Inc (AAPL) has sold in the country over the last 12 months. Although the recent market reaction to China’s decision may be an exaggeration, Apple Inc (AAPL) still seems richly valued today, leaving investors with no margin of safety.
Upcoming iPhone 15 Launch and Challenges
Apple Inc (AAPL, Financial) is scheduled to launch the iPhone 15 series on Sep. 12 at a special event, and the new devices are expected to go on sale starting from Sep. 22. As usual, analysts, investors, and Apple enthusiasts are eagerly waiting for the launch event to get an idea about the innovative features packed into the latest iPhone models. Although these new iPhones may help Apple Inc (AAPL) gain some lost traction in the stock market, investors will have to pay close attention to some of the challenges that are looming on the horizon.
Production Cuts and Regulatory Risks
Popular Apple analyst Jeff Pu slashed his forecast for iPhone 15 productions for 2023 from 83 million to 77 million a couple of weeks ago citing supply-chain challenges and worse-than-expected demand. Although supply-chain challenges can be overlooked as these obstacles are likely to prove short-term in nature, waning demand for new iPhones is a concern that needs scrutiny.
Following Jeff Pu, Mizuho Securities also reduced its production estimates for iPhone 15 devices this year from 84 million to 73 million citing supply-chain challenges. Accordingly, Mizuho now estimates 217 million iPhone devices in use at the end of this year, down from its previous estimates for 227 million active devices globally.
In addition to production cuts, Apple Inc (AAPL, Financial) faces regulatory risks as well. China’s threat to Apple is well documented, but many investors seem oblivious to the threats faced by the company in Europe. The enforcement of the Digital Markets Act by the European Union will bring new challenges for Apple Inc (AAPL).
Impact of the Digital Markets Act
The EU identifies Apple as a gatekeeper, and it plans to enforce new antitrust rules on each of these identified gatekeepers including Apple. The EU has confirmed that the App Store is subject to these new rules, meaning Apple Inc (AAPL, Financial) will have to adhere to these guidelines to avoid being fined 10% of its global annual sales. Some of these new rules include creating a fair environment for third-party service providers to compete with Apple’s own products and services, not ranking products offered by Apple favorably on its platforms, and even agreeing to not track user activity outside of Apple’s core platforms.
Apple Inc (AAPL, Financial) is already contending these rules, and it is not clear whether iMessage is also covered under these rules. In any case, the company is likely to face heightened scrutiny in Europe, which might end up in financial losses for the company in the form of fines, money spent on complying with new regulations, and loss of revenue resulting from increased competition from other service providers.
Apple's Valuation and Economic Reality
Apple Inc (AAPL, Financial) is currently valued at a forward price-to-earnings ratio of 28.74 compared to its 5-year average of 23.8. From a historical valuation perspective, the company seems expensively valued today. This can be confirmed by looking at price-to-sales multiples too. Today, the company is valued at a P/S multiple of 7.3 compared to the 5-year average of 6. Before 2018, Apple Inc (AAPL) used to be valued at much cheaper valuation levels, but things changed for the better with the rollout of 5G technology as the market rewarded Apple for being a frontrunner in the smartphone upgrade supercycle that was triggered by 5G.
After reaching a new high in 2021, global smartphone shipments declined by 12% in 2022. According to data from Counterpoint Research, 2023 is on track to be the worst year for smartphone shipments in 10 years, with the number of smartphones shipped expected to fall by 6%. These findings suggest the 5G-induced smartphone upgrade supercycle is maturing. Under these circumstances, it does not make sense for Apple Inc (AAPL, Financial) to trade at a premium to its historical average given that smartphone shipments boomed in 2021.
Investing in Apple: A Risky Bet?
Apple Inc (AAPL, Financial) is a well-managed company that is likely to earn economic profits in the foreseeable future thanks to its strong positioning in the global smartphone industry, the brand value associated with the company which allows premium pricing, and the diversification into the services category. However, Apple Inc (AAPL)’s current valuation does not seem to reflect the true economic picture behind the company given that smartphone shipments are slowing down at a time when the company is facing regulatory hurdles in Europe and China – two of its key markets. Although long-term-oriented investors may not want to distance themselves from Apple Inc (AAPL) in light of these risks, investing in the company at these prices seems a risky bet.
