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How the iPhone 8 Could Solve Apple, Inc.'s China Woes

By Evan Niu, CFA – Aug 29, 2017 at 7:09PM

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A redesigned flagship iPhone could do the trick with unlocking pent-up demand, according to Morgan Stanley analyst Katy Huberty.

We're now exactly two weeks away from when Apple (AAPL -4.91%) will reportedly host its annual iPhone event, which is now unofficially pegged for September 12. Meanwhile, investors have remained concerned over the past couple of years about Apple's performance in China, as sales have stalled. The prevailing notion, derived largely from unit shipment data, is that local low-cost vendors continue to eat into Apple's market share.

Besides, the numbers appear to speak for themselves:

Chart showing year-over-year revenue growth in Greater China falling

Data source: SEC filings. Chart by author. Calendar quarters shown.

However, there could be more to the situation than meets the eye.

Word on the Street

Morgan Stanley's longtime Apple analyst, Katy Huberty, recently sat down with Business Insider to discuss Apple's prospects as well as her ambitious $183 price target on Apple shares. Huberty believes all of the pessimism surrounding Apple's business in China is being overblown, arguing that the stalling sales are a result of pent-up demand as opposed to losing competitiveness to local brands.

Huberty points out that all of Apple's other offerings are enjoying strong growth in China, including the Mac, iPad, and services. "It's highly unlikely that Chinese consumers are paying $2,000 for a Mac at home, but carrying a cheaper smartphone device with them," she tells Business Insider. On the earnings call earlier this month, CEO Tim Cook noted that Mac unit sales hit a new record for the June quarter in Mainland China and Japan, and iPad unit sales posted "strong double-digit increases" in several important markets, including China. Over half of iPads sold in China and Japan are going to first-time buyers.

Multiple iPhones in Chinese language

Image source: Apple.

There may be another possible explanation for stalling iPhone unit sales in China: the extended design cycle that Apple used with the iPhone 7. Apple took a risk in using the same overall design for the third year in a row, something it had never done before.

Consumer markets are generally fairly sensitive to changing form factors and designs, and this could be particularly noticeable for high-end Chinese consumers, in Huberty's view. With a dramatic redesign expected in the forthcoming iPhone 8, that could be the key to unlocking all of that pent-up demand. The analyst adds, "We believe that Chinese consumers are just waiting for that change."

Huberty estimates that iPhone sales will jump 23% next fiscal year, driven in part by China.

Time for a turnaround

Much like in the rest of the world, Apple's overall business has long relied heavily on the iPhone, so it's entirely feasible that any iPhone weakness in China could depress reported results and have a disproportionate effect on its Greater China business, even as the company makes gains with the Mac, iPad, and services. The flip side of that would be that if the iPhone 8 proves to be a huge hit in the Middle Kingdom, it could single-handedly facilitate a turnaround in financial results.

As is often the case with iPhone launches, generating demand is the easy part. Ramping production to keep up with that demand may prove more difficult, particularly with expectations of severe supply constraints for the new OLED-equipped flagship.

Evan Niu, CFA, owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has a disclosure policy.

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