Apple (NASDAQ: AAPL) is a $1.35 trillion colossus with manufacturing and sales divisions spanning across the world. Given its enormous size, conflict across the world can affect the company and its share price. The purpose of this article is to quantify the potential share price impact from 2019-nCoV and show how, despite the importance of China to Apple, the impact will not be as large as investors fear.
Apple Manufacturing Portfolio and Risk
Despite the small size, the iPhone is one of the most complex devices ever created and the manufacturing portfolio highlights this. Let’s start by delving straight into the most important part of this discussion – Apple’s manufacturing portfolio and the risk it faces.
The above image provides the number of suppliers that Apple has per location. You can see that Apple has hundreds of suppliers from the iPhone. The majority of these are in China (more than 300), however, it’s important to note that China is an enormous country. Just to give evidence, the province of Tibet, thousands of miles from the virus, has 0.2% of China’s population but has had 0.005% of the cases (exactly 1).
Specifically, where Wuhan is an inland province towards the center of the map where China has a total of 4 suppliers out of 100s.
To attempt to quantify the significance of China’s Apple supplier we can take a look at Apple’s supplier list which highlights the company’s top 200 suppliers based on the number of $ Apple spends with that supplier. Out of these, exactly two are in the Hubei Province (where 66% of all recorded cases of the virus have occurred so far). These two are Asia Vital Components Company Limited and Foxconn.
However, it’s important to note that Asia Vital Components Limited has 4 locations in China and Foxconn has 35 locations inside China. Each company has exactly one company in the Hubei province. Asia Vital Components Limited markets itself as “the leading total thermal solution provider in the world”, with a portfolio focusing on laptop and thermal heating and cooling solutions.
Specifically, while Apple doesn’t list what it purchases from each supplier, it’s likely that Asia Vital Components Limited provides Apple with some part of the cooling solution used in its Macbook laptop line. This good news for Apple shareholders, from a manufacturing perspective heat sinks and fans are relatively easy to manufacture elsewhere (versus complex silicon like DRAM chips).
In fact, by poking around on Alibaba some, I was able to find Apple Macbook Pro heat sinks and fans (i.e. the various components of the Macbook Pro cooling system) available for sale. The company listed as selling these products is from Shenzhen, China, or one of China’s major industrial cities in Guangdong. For reference, Guangdong is the location of 125 out of Apple’s top 200 suppliers.
Let’s move onto Foxconn. Foxconn is a unique company, because it’s by far Apple’s largest and most important supplier (as defined by the 35 locations in China). In fact, Foxconn is responsible for “iPhone City”, a sprawling manufacturing complex where half of the world’s iPhones are made. In fact, Foxconn is such an important Apple supplier, Apple has forced it to spread to diversify, Apple’s risk, it recently started a new factory in India and it’s working on a Wisconsin factory.
In fact, Foxconn is such a significant company inside China and to Apple that statements and stories have begun to come out. So far, for its part, Foxconn has reportedly seen a small impact from the 2019-nCoV coronavirus and reports that it will be able to hit all manufacturing targets. However, that’s due to the company moving affected production to countries outside of China.
Foxconn currently has shut most of its production inside China and, reportedly, production will stay shut for at least one more week. The company believes it can make up production through working those in the Chinese factories overtime once they come back online combined with production in factories outside of China. However, that implies that in a longer term shutdown, goals will not be hit.
Specifically, this the risk that Apple’s manufacturing portfolio faces. More importantly, it’s important to keep in mind that our share price worst case impact discussed below is much more unlikely due to the location of manufacturing facilities outside of Hubei.
Before we turn the above discussion into an effect on Apple’s share price and revenue, we need to discuss the current state of the 2019-nCoV coronavirus along with potential spread and the response.
The above image, from the John Hopkins University monitoring center, provides the latest update on the virus as of February 4, 12:15 am PST. Specifically, there are 20,636 cases of the virus, of which 20,444 are in mainland China. Every single case of the virus, except, for 192 have been in mainland China and only one death has occurred inside mainland China.
I want to preface this by stating I am not a doctor and do not have a medical degree, however, I have studied infectious diseases previously and have significant college level biology experience.
There’s several major items about 2019-nCoV worth highlighting. The first is that there has yet to be confirmed person-person spread from an asymptomatic person. This important because that would make the virus significantly harder to control. A recent study in the New England Journal of Medicine indicated this had been confirmed, however, another follow-on update indicated that this study was flawed.
The second is that countries have responded strongly to 2019-nCoV, fully closing borders despite the opinion of the WHO. I personally believe this the correct response. The United States has 11 confirmed cases with 82 under observation, and has announced strict measures such as a full-quarantine of Hubei province visitors for 14 days. That guarantees these visitors can’t spread the virus.
Other countries have undergone a similarly strong impact. China has effectively isolated the Hubei province and shut down the country for several weeks to stop the spread of the virus. In fact, the increase in cases is due to the rapid increase in test kits, from a previous shortage, with new kits able to detect the virus in as little as 15 minutes and going into mass production in <10 days.
Still the virus has already reached an estimated 100 thousand people and with an R Naught (how many people each infects) estimated at 2 – roughly as contagious as the common cold. That’s a lot of people to contain.
There is some hope. New drugs, such as Gilead Sciences’ Remdevisir (originally created due to potential Ebola Virus benefits) is being rushed ahead into human trials. Vaccines are being fast-tracked with countries hoping to start human trials within 3 months and the United States leading the way here. For reference, it will still take close to a year for a mass produced publicly available vaccine.
Realistically, at this point, there’s two possible avenues the virus can take. The first is that drug treatments help reduce the death rate and combined with the massive efforts to quarantine people, result in the virus becoming controllable (cases outside the region are managed and the region remains closed off for the 2 weeks) until the outbreak slowly declines over the next few weeks with the impact not spreading.
The other possible avenue is the virus reaches an unbreakable point of human spread – like Swine Flu which affected an estimated one out of 6 people in the United States by the time it was done. Work is rushed on antiviral drug trials and a vaccine and it takes approximately 3-4 months for them to lower the death rate based on current plans for vaccines.
This also in line with other estimates that if the virus reached peaked spread it would take several months. Until then, depending on the strength of existing antiviral drugs the world might grind to a halt or ignore it.
Interestingly enough, from a manufacturing point of view, the net effect here is the same. If the virus achieves global spread in the next 1-2 months it’s meaningless to halt all manufacturing, in fact, global integrated manufacturing would be essential to sufficiently help those suffering. Alternatively, China continues the shutdown for up to 1-2 months in the most affected regions, until the spread of the virus dies down.
Either way, the current statistics indicate that the potential disruption to manufacturing will range from 1-3 months. It’s also worth noting, looking at past flu outbreaks, the time from early outbreak to peak was <3 months along with the time from peak to near disappearance. This continues to support our thesis that the maximum disruption across different scenarios is 1-3 months.
Taking the potential 2019-nCoV spread and response into account, we can discuss the potential Apple share price impact and income impact. This especially important to take into account due to Apple’s plans to expand iPhone and Airpod Pro production in the light of strong sales. First, as I highlighted in my recent Apple article here that I recommend reading, Apple’s overall business remains strong.
The company guided for potential impact from 2019-nCoV in its Jan. 28 1Q update, which has the up-to-date statistics the company expects from its manufacturing plant. It highlighted revenue guidance at $63-67 billion, however, which is a ~10% YoY revenue increase. More importantly, this guidance with a larger downside range ($63 billion) is already factored into the share price.
Past this, we will assume a worst-case scenario where Apple manufacturing is cut in 100% for 3 months. That means 90 days of no production, and Apple currently has just under 7 days of inventory or 83 days of no production (~1 quarter). Interestingly enough, even in this scenario, where Apple effectively loses a quarter of sales, it loses ~$3.0 / share in EPS for the quarter.
Additionally, the company will lose its $9.7 billion in operating expenses for the year (I presume the company will choose not to fire workers for this). That’s another $2.2 / share in lost value per share for a total of $5.2 / share. Interestingly enough, Apple’s $15 in share price drop over the last 2 market sessions is three times the forecast worst case drop.
Theoretically we can expand this by an extra $1 per share by because Apple builds up inventory throughout the year for the 1Q of each year, which is particularly big, as the planned iPhone and AirPod ramp ups show. However, there’s some other aspects in our forecast that are worth noting that make it by far a worse case. Specifically, we assumed no mitigation abilities and that the purchases simply disappear.
It’s clear these are far exaggerations.
First, as we discussed above, Foxconn has already started to move production outside of China to other factories. Even in a total China shut down, the chance of every factory worldwide being closed for 3 months is incredibly small. Second, we assumed that if someone doesn’t purchase a product in the 3 months, because of the virus, they’ll never purchase another iPhone.
More importantly, the replaceability of Asia Vital Components discussed above and the distribution of Foxconn’s factories mean the Hubei shutdown itself is minimal so further manufacturing impacts would require the quarantine to spread, which is very unlikely.
However, if my phone breaks, and I can’t buy a new one because of manufacturing issues, that doesn’t mean I’m never buying a new phone again. If I’m excited about the Airpod Pro – I’m still going to be excited in 1-2 months. And service revenue won’t go to 0, if I’m stuck in a quarantine, I guess it’s time to checkout Apple TV or buy a new game from the app store.
However, as we can see, the impact from 2019-nCoV has already been more than highlighted in Apple’s share price, and as a result, I stand by my thesis in my last article that Apple has never been stronger.
Any thesis in the world has risks and it’s worth highlighting three potential risks to ours that shareholders should pay attention too. They are the risk of a recession, decrease in population, and virus mutations.
The first is the risk of a recession. We are currently in the midst of the longest bull market in history. As market growth rates have begun to slow, there are fears that the global slowdown caused by 2019-nCoV could lead to a recession. SARS caused a 2% decline in China’s GDP and 2019-nCoV is already thought to have surpassed that. Most think that if China fails to contain the virus, a global recession could come.
A global recession has the potential to have a much larger impact on Apple’s sales than 2019-nCoV itself.
Additionally, another potential risk is a decrease in population. It might sound insignificant but the virus has a 2% case-fatality rate. As we discussed above, 1 of 6 people got Swine Flu. Assuming similar spread and no ability to treat the virus, this indicates 0.3% of the global population dying. The effects of this would be dramatic and unprecedented – WW1 killed an estimated 1% of the world’s population.
Lastly, virus mutations are worth paying attention too. Viruses mutate and change how they spread regularly – it’s the reason why a new flu vaccine comes around each year. Technically, 2019-nCoV could mutate into a new and more virulent strain (something like measles which is currently 10x as contagious as 2019-nCoV) or into something with a higher death rate, each of which could have larger ramifications.
However, it’s also worth noting the impact would have to triple to justify the current stock price drop.
Apple has seen its stock price drop by $15 / share since the 2019-nCoV outbreak began to pick up steam (~5%) a share. The numbers around the virus remain concerning, as the number of cases continue to increase drastically. The market considers this especially concerning Apple, which has significant manufacturing facilities across China.
However, as we can analyze this throughout a number of different lenses, we can see that the peak net cost to Apple is ~$5.2-6.2 / share making some draconian assumptions. This 33% of the decline in Apple’s share price as a result of fears of 2019-nCoV and it helps to highlight how the market is overreacting to these fears. The potential impact from 2019-nCoV is minimal and I recommend investors use the drop as an investment opportunity.
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Disclosure: I am/we are long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.