With a trade war brewing between the U.S. and China, investors have been anxiously waiting to see how the back and forth between Washington, D.C., and Beijing will play out. It's difficult to know how an all-out trade war would affect investors, but the uncertainty weighs heavy on the market, as Wall Street despises uncertainty.
One company that has thus far been spared the effects of the escalating trade tensions is Apple (AAPL -5.64%). However, the company's inexorable links to China are clear: The majority of Apple's manufacturing operations are located in the Middle Kingdom, and the country represents a significant market for Apple's products.
With such strong ties to China, it was inevitable that Apple would eventually feel the impact of the growing tariffs that are being slapped on imports on both sides of the Pacific. In a recent filing with the U.S. government, Apple says a day of reckoning is coming.
Hoping that "calm heads prevail"
In its third-quarter financial report, Apple reported revenue of $9.55 billion from Greater China, up 19% year over year, and representing 18% of Apple's total sales. During its quarterly conference call in late July, Apple CEO Tim Cook said it was the "fourth consecutive quarter that we've had double-digit growth in Greater China," producing "double-digit growth from services, to iPad, to iPhone, and to our Other Product category in which the [Apple] Watch did extremely well, and so there are lots of good things happening there."
At the time, Cook pointed out that there were a number of tariffs at various levels of implementation, saying the company had yet to be feel the pinch. "I am optimistic that the countries will get through this. And we are hoping that calm heads prevail," Cook said.
That early optimism has given way to a fair degree of concern. In a filing with the U.S. Trade Representative dated Sept. 5, Apple told the Trump administration that the recently proposed tariffs on $200 billion in products imported from China would affect "a wide range of Apple products" -- calling out the AirPods, Apple Watch, and the Mac Mini computer.
Apple said that "all tariffs ultimately show up as a tax on U.S. consumers." The latest round would effectively impose a 25% tax on the company's finished products, or on the components that are used to make them. Any potential increase in costs would either be passed on the customers, resulting in lower sales, or absorbed by Apple, pummeling its bottom line.
Hitting Apple where it hurts
It's important to note that Apple's Other Products category, which includes the Apple Watch and AirPods, has been the company's fastest-growing segment, up 37% year over year in Apple's third quarter. In its conference call to discuss the results, Cook highlighted "wearables" -- a subset of its Other Products segment -- as an example of the company's continuing success:
Wearables, which comprises Apple Watch, AirPods, and Beats, was up over 60% year-over-year with growth accelerating from the March quarter. Our wearables revenue exceeded $10 billion over the last four quarters, a truly remarkable accomplishment for a set of products that has only been on the market for a few years. Apple Watch delivered record June quarter performance with growth in the mid 40% range.
It's telling that each of those products was mentioned in Apple's filing with the U.S. Trade Representative -- the devices seeing the fastest growth could be hit the hardest.
It could get worse before it gets better
With the recent proposed tariffs set to impact Apple's fastest-growing product category, it's easy to see why Apple would "urge the Administration not to apply tariffs on these" products. The filing went on to say "it is difficult to see how tariffs that hurt U.S. companies and U.S. consumers will advance the Government's objectives. ... We hope, instead, that you will reconsider these measures and work to find other, more effective solutions."
Unfortunately, the situation will likely get worse before it gets better. President Donald Trump said late last week that he was prepared to escalate the trade war further, imposing duties on virtually all imports from China. That would result in tariffs on another $267 billion in goods, on top of the $200 billion in potential duties addressed in Apple's filing and the $50 billion under tariffs already enacted earlier this year. The goods falling under total proposed tariffs exceed $517 billion, which would top the $505 billion in goods imported from China in 2017.
This was likely not the news that Apple -- and investors -- were hoping to hear.