Stock investment – How Much Could China’s Currency Impact Apple Inc.’s Earnings? — The Motley Fool



Stock investment –

Source: Apple

The sharp devaluation of China’s currency is one of the market’s biggest stories this week.

The abrupt move affected nearly every major asset close around the globe, triggering a flurry of speculation of what the PBOC’s move will mean for American companies of all shapes and sizes. Tech giant Apple garnered plenty of attention in this discussion, which is certainly understandable given its increased reliance on China to fuel its future growth.

To be clear, though, the devaluation of the Chinese yuan will likely adversely impact Apple in one of two ways. But as you’ll see below, the impact will likely inflict far less damage than recent headlines would have you think.


A two-sided coin
Understanding currency relationships requires you to think in terms of the relative relationships between two countries. Keeping things surface-level for the purposes of this discussion, a change in the value of the currency of Country A shifts the amount of goods and services its trading partner Country B can theoretically purchase from Country A.

Although it has made moves to liberalize its currency markets, China still sets an official exchange rate for its relationship with the U.S. dollar and a band around which the two currencies can trade to provide some flexibility to the relationship. This week, China mostly lowered its target for the yuan/renminbi to dollar ratio by nearly 3%.

 

Aug. 10th

Aug. 14th

% Change

U.S. Dollar-Chinese Yuan/Renminbi Exchange Rate

6.21

6.39

2.90%

Source: Bloomberg 

So, in effect, any good or service a foreign buyer wants to purchase from China just became about 3% cheaper, a move that should help spur economic activity for China’s economy. The flipside of this, though, and thus the two-sided coin reference above, is that this move also makes importing goods and service from abroad about 3% more expensive for the Chinese, and this fact specifically spooked Apple observers.

Two ugly choices for Apple
This leaves Apple stuck choosing between two largely unattractive options in responding to this surprise Chinese devaluation. First, it could simply live with this new exchange rate, which effectively creates a 3% haircut on all sales of its products in China. Obviously, this course dampens the profitability of Apple’s entire Chinese operation slightly. The other option, and the more likely of the two in my estimation, is that Apple will raise prices on its iDevices in China.

In keeping with its high-end brand image, Apple has a long history of raising its product prices rather than live with fluctuations in foreign exchange markets hampering its profitability. This could shave off some demand for Apple’s products on the margin in China, but such a move might also help reaffirm the luxury status of Apple’s products in the minds of Chinese consumers as companies like Samsung take aim at its larger-screened iPhones.

Much ado about nothing?
The strong U.S. dollar of late has provided headwinds for U.S. corporate earnings abroad for several quarters now, so the Chinese yuan devaluation largely represents a continuation of this storyline. A few more important points bear noting here before closing.

First, Apple also sources a significant portion of its inventory and virtually all its product assembly in China, so at first glance, Apple could see an equivalent cost savings on its input costs as a result of this event. Not so. As a number of shrewd analysts have noted, Apple’s supplier contracts with its Chinese parts and fabrication partners are denominated in U.S. dollars, so it will not realize any cost savings here. By denominating contracts in the company’s home currency Apple insulates itself from potential inventory writedown risks, so it’s actually good business on Apple’s part. Also, large companies like Apple routinely hedge at least some of their foreign currency obligations, so Apple’s net exposure to the yuan’s downward swing might not hurt as much as it appears on paper. Lastly, remember the PBOC’s actions help spur economic activity, so this move might actually serve to bolster demand for Apple’s products down the road.

As I commented earlier this week, the recent signs of slowing growth in China and the negative psychological effects it could have on consumer spending worry me slightly more then the fairly minor swing in an admittedly important exchange rate relationship. But at risk of missing the forest for the trees, Apple still enjoys ample growth opportunities as the multi-decade Chinese growth story likely remains intact, even if conditions degrade further in the coming months.

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– Stock investment

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