The ripples from China’s stock market crash are finally hitting American shores, causing significant damage to Apple Inc. (NASDAQ:AAPL) in particular. Declining equity prices and falling exports forced a devaluation of the yuan, causing the currency to weaken against the dollar.
At first glance, a depreciating yuan seems like a good thing for Apple. The smartphone giant sources parts and production from suppliers in China, most notably the electronics manufacturer Foxconn Technology Group. The logical conclusion is that a stronger dollar implies lower costs for Apple, but a detailed reading of their supplier contracts shows otherwise. (Source: Vox, August 26, 2015.)
Apple shares have lost more than 12% of their value in the last six months. The exodus of capital was becoming so worrisome that Tim Cook, the CEO of Apple, e-mailed a CNBC host to diffuse the tension.
Writing to Jim Cramer, host of Mad Money, Tim Cook said that “I get updates on our performance in China every day, including this morning, and I can tell you that we have continued to experience strong growth for our business in China through July and August.” (Source: CNBC, August 24, 2015.)
Tim Cook: iPhone Sales Are Up in China
Despite Cook’s positive take on the situation, there’s a key discrepancy he didn’t address. Apple has separate contracts with retailers and suppliers. While contracts with suppliers like Foxconn are fixed in U.S. dollars, the retail sales in China are denominated in yuan.
China represents 27% of Apple’s business, and 50% of its revenue growth, which is no small sum. Even if the company sells more iPhones and iPads, as Cook claims, the value of each sale is less when it’s converted back to dollars.
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As a result, the devaluation of the yuan severely erodes Apple’s profitability. With North America’s smartphone market having matured in recent years, China was meant to provide a new frontier for growth.
Apple could try adjusting prices to balance the foreign exchange loss, but that would negatively impact sales. Very often, firms with international exposure will employ currency hedges using derivatives, but China’s tightly regulated market makes it onerous.
The devaluation is unlikely to damage Apple in the long run, but it may significantly alter the company’s near-term growth prospects.
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