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Should Apple, Inc. Fear a China Slowdown?

By Jamal Carnette, CFA - Jan 19, 2016 at 3:15PM

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What to make of China's slowing GDP growth.

Apple Store in Beijing. Image Source: Flickr user Chinnian (CC By SA 2.0 license).

Recently, the Chinese government reported its official growth rate. Versus the official growth target of 7%, Beijing reported a year-on-year growth rate of 6.9% in 2015, down from 7.3% in the prior year. On a comparative basis, this would seem to be extremely strong growth when compared with the United States' growth rate of 2%-3%, but this is a tepid result from the world's second-largest economy. When compared with China's recent history, this is the slowest growth the country's experienced in the last 25 years.

Furthermore, as a result of its above-average growth and large GDP output, China's GDP is an important barometer to the world economy. In the United States, there are few higher-profile companies that have staked their future growth on China quite like Apple (AAPL -0.14%), with CEO Tim Cook going to great lengths to calm investors in regard to the company's sales path in the Middle Kingdom.

And there's a lot at stake here for Cupertino: Over the past four quarters, the company increased its revenue in China 84% on a year-on-year basis, mostly on the back of strong iPhone sales. For a quarterly breakdown on China growth, see the following graph.

Source: Apple's 10Qs. Figures in millions.

So the broad thesis is China is slowing and Apple's dependent upon growth from China -- therefore, Apple investors should be worried, right? That's a simple thesis, but its effects are probably overstated.

Total GDP is a broad metric
GDP is defined as the total dollar value of all goods and services produced in a country during a given time frame. As such, the measure is very broad and is only a place to start from if you're employing a top-down analysis. And while many economists argue that, in the long run, successful companies will mature and only grow national revenue at the rate of GDP growth, in the short run these figures will vary widely. For example, look no further than Apple's amazing growth rate last year in China versus the backdrop of the country's 6.9% growth rate.

Interestingly enough, the smartphone market seemed to cool even more than the overall economy with sales even decreasing in China during the second quarter, according to Gartner. Apple was able to grow anyway, registering a 112% growth rate during its corresponding third fiscal quarter, as China's smartphone market is morphing into a saturated, upgrade market, rather than a first-time-buyer market. In the end, Apple's brand cachet won over many first-time buyers. Apple actually does better in these maturing markets, as users start to prioritize experience over cost.

That doesn't mean Apple's growth rate won't slow
However, this doesn't mean Apple's growth rate in China will not slow. But this is mostly due to the "tough comparable" conundrum more so than a declining growth rate. As a result of Apple's tremendous performance in China during the last fiscal year, the company would have to $108 billion in China alone, making it Apple's largest market. Apple will continue to grow revenue in the country, but look for the rate itself to slow.

That doesn't mean there aren't risks in the country. Many economists are predicting increasing sluggishness in China's economy -- the so-called "hard landing." In fact, many economists claim China's growth is weaker than the official numbers, although China denies they're inflating the numbers. The widely respected International Monetary Fund expects China's economy to further cool and diverge from the official 7% target by announcing GDP growth rates of 6.3% this year and 6% in 2017. The macroeconomic picture in China may leave a little to be desired, and Apple's growth rate should naturally slow this year, but investors shouldn't be fearful of Apple's path forward in China because of slowing GDP growth.

 

Jamal Carnette owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool recommends Gartner. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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