Clear-Headed Thinking Ahead of December Tariffs

Clear-Headed Thinking Ahead of December Tariffs

In May, we wrote that the fear of tariffs was leading investors to make false predictions, causing distortion to the financial markets. We suggested taking the approach of sober analysis based on what is known rather than speculation. At the time, there were questions about how Apple would be impacted.

Now we have more facts. Apple does pay tariffs today, some that went into effect before September and others started in September. That said, the company does not comment on tariff offsets that it continues to receive that lessen or eliminate the impact of the tariffs on Apple’s cost of goods.

The anxiety around additional Apple tariffs has abated since May but still lingers with investors as evidenced by AAPL’s 2% decline this week following comments from President Trump that the China trade dispute would likely be prolonged, along with the reiteration that potential new tariffs are scheduled for December 15.

These proposed 15% tariffs include smartphones for the first time. Given the inclusion of smartphones, the December additions represent the greatest tariff risk to date for Apple. iPhone will account for about 52% of revenue in FY20, down from 55% in FY19 and 62% in FY18.

Indications Suggest Apple Has Little Risk

The key question of course is will Apple be exempt from the next phase of tariffs? Our answer is ultimately Apple will be exempt or provided levers to offset the impact of tariffs. This is based on five indications (in order of importance):

  • Dec-19 guidance. At the time Dec-19 guidance was issued, Apple was aware of the proposed December tariffs. Cook talked about his “positive” December view when answering a question related to tariffs. Given the company’s conservative nature, if there was a risk of new tariffs impacting iPhone profitability, that view would have presented itself in Dec-19 gross margin guidance. Instead, Apple guided the gross margin midpoint to be flat from Sep-19 to Dec-19 at 38%.
  • Recent comments from Trump. President Trump’s Nov 20th comments at the Apple Austin event seem to publicly all but rule out additional Apple tariffs. Specifically, the President said that he’s “looking into” whether Apple should be exempt from tariffs on Chinese imports in an effort to level the competitive playing field with Samsung, which benefits from a US-South Korea trade agreement.
  • Trump respects Cook. Cook’s unique status and relationship with Trump has been well documented but is worth mentioning. At the Austin event, Trump commented, “Tim Cook is somebody that I greatly respect — a great leader, a great businessman.” It appears, at a personal level, Trump wants Cook to succeed, and the President can advance that goal by providing an exemption or offsets to limit their impact.
  • September precedent. The fact that Apple was provided offsets in the previous Sep-19 tariff rounds sets a small precedent that they will receive future offsets.
  • Macro softness. General macro softness suggests that tariffs and the resulting pressure on Apple, the US’s largest consumer tech company, during the critical holiday buying period would be ill-advised.

Timing of Clarity

Using the Sep-19 tariffs as a benchmark, Trump will likely announce the tariffs around December 15th, but it will likely be a couple of months before we get clarity on their impact on Apple’s business. We expect the first material update at the end of January when Apple reports its Dec-19 earnings.

Looking back to Apple’s Sep-19 earnings call, Tim Cook first addressed tariffs in response to an analyst question, stating “we’re paying some tariffs today, as you know, some that went into effect pre-September and some others that went into effect in September. So we are paying some. That’s been comprehended. But in general, my view is very positive in terms of how things are going. And that positive view is obviously factored in our guidance as well”.

We patiently await Cook’s response to the question on the company’s late January earnings call.