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Trump's Tariffs Could Crush Apple's iPhone Margins

By Evan Niu, CFA – May 14, 2019 at 3:45PM

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The Mac maker might eat the costs.

Amid President Trump's escalating trade war with China, Apple (AAPL 0.21%) could get hit hard as the tech giant gets caught in the crossfire. Trump, who consistently and inaccurately claims that China pays the tariffs, had reportedly previously considered slapping a 10% tariff on the iPhone. The president began the process last Friday of raising tariffs on $200 billion worth of Chinese goods. They aren't expected to take effect until later this summer.

Apple's margins could take a major hit as a result.

Customers shopping for iPhones in an Apple Store

Image source: Apple.

iPhone gross margin could decline by 4 percentage points

The Cupertino tech giant hasn't been dramatically affected by any of Trump's tariffs up until now, but the latest move could substantially increase the costs associated with a greater number of components that it uses in the iPhone.

JPMorgan analysts put out a research note this morning (via CNBC) estimating that Apple would need to jack up the already high price of the iPhone XS by 14% just to cover those costs, factoring in specific components that would be affected and assuming suppliers maintain their own profitability. The iPhone XS currently starts at $1,000, which would need to be increased to approximately $1,142 to offset the tariffs, according to the report.

However, the analysts do not think that Apple would pass along the tariff costs along to consumers in the form of price increases, instead potentially absorbing them directly. iPhone unit sales have been declining, in part due to the company's premium pricing combined with a slowdown in the global smartphone market that is hitting the high end of the market particularly hard. Raising flagship iPhone prices even further would threaten to significantly hurt demand for Apple's most important product in its biggest market.

If Apple were to eat the tariff impact, iPhone gross margin could decline by 4 full percentage points, according to JPMorgan's estimates. Apple doesn't directly disclose iPhone gross margin, but that would be a huge hit to profitability. The company's overall gross margin was 37.6% last quarter.

The estimates are comparable to those of Morgan Stanley analyst Katy Huberty, who last week figured that Apple would need to raise the iPhone XS price by approximately 16%, and that absorbing the tariff costs would hurt net income by 23%.

No easy solutions

The prospect of higher tariffs is now becoming a very real risk to Apple, at a time when it is already grappling with challenges in its hardware business. The all-important services business wouldn't be directly impacted by tariffs, other than the potential that slowing hardware sales weigh on installed base growth. Additionally, services represented just 20% of revenue last quarter (but a third of gross profit due to its high-margin nature).

Perhaps most disconcerting is that there is little that Apple can do in the short term to avoid the tariffs. The company is starting to ramp up iPhone production in nearby India, but the vast majority of production remains heavily concentrated in China, and relocating its entire supply chain is simply impossible.

Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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