China's consumers deliver for Apple—but for how long?

The newly opened Apple Store in Nanjing, Jiangsu Province of China
ChinaFotoPress | Getty Images
The newly opened Apple Store in Nanjing, Jiangsu Province of China

As analysts and investors eye prospects for Apple stock, many are drilling down on the company's sales and earnings prospects in China, its biggest overseas market.

On Wednesday, the company's stock was down as much as 5 percent, a day after the tech giant reported disappointing sales of the iPhone and the slowest year-over-year growth ever for the blockbuster device. That news raised a red flag, since those sales account for two-thirds of Apple's total revenue.

In response, Apple CEO Tim Cook remained confident on the outlook for China. He noted that Chinese incomes are rising and their savings rate is among the highest on the planet. China's consumers sent retail sales up 11 percent year-over-year in December — not very ruffled, for now, by the nation's market turmoil.

The question, for Apple, is whether that confidence can last: Cook noted in a conference call after Apple's earnings announcement Tuesday that sales in Greater China, especially Hong Kong, began to "soften" in January. But for now, China's consumers are the reason why Apple execs rattled off a list of eight nations and regions they were worried about, from Canada to Turkey, without mentioning China.

"Young urban Chinese elites have savings, so they can afford it,'' said Todd Lee, senior director of economic consulting firm IHS Global Insight.

The damage was less for the simple reason that China's consumers are relatively flush, even as the nation's investment and export sectors are enduring shocks. Their savings rate is about 38.5 percent of income, and average per capita disposable income rose 7.4 percent in 2015, even as China's financial markets whipsawed throughout the second half of the year.

That's also a reason why expectations are fairly high for the Jan. 28 report from Chinese e-commerce giant Alibaba, which RBC Capital Markets analyst Mark Mahaney said will boost adjusted profit per share by 31 percent. Consensus estimates are lower, calling for a 25 percent gain.

Apple said its overall profit for the first quarter of its 2016 fiscal year rose 1.9 percent, to $18.4 billion, or $3.28 per share, from $18 billion and $3.06 a share last year. (The 7.2 percent gain in per-share earnings reflects stock buybacks that reduced Apple's share count.)

Sales rose 1.7 percent, to $75.9 billion, but would have been up 8 percent if the value of the world's different currencies had stayed the same as last year, Apple said. "The difference is about the size of an average Fortune 500 company," Cook said.

iPhones' average price was reduced by $49, to $691, by the rise in the U.S. dollar, which makes each sale in local currency abroad less valuable to U.S.-based shareholders. Currency is also the reason for about a third of the drop in revenue that Apple projected for the March quarter.

Market forces at work

By contrast, Apple's Brazil sales fell because of a 40 percent drop in the Brazilian real that required Apple to raise iPhone prices there, dragging overall sales in the Americas 1 percent lower. Japan was down 12 percent, sales in Russia were hurt by the collapsing price of oil and the ruble, and the falling euro combined with Russia's woes to turn an 18 percent European sales gain in constant currency into only a 4 percent as-reported gain. Apple now gets two-thirds of its revenue from outside the U.S.

"Major currencies, such as the Canadian dollar, Australian dollar, Mexican peso and Turkish lira have declined 20 percent or more," Cook said, adding that "$100 of Apple's non-U.S. dollar revenue in Q4 of 2014 translated to only $85 last quarter due to the weakening currencies in our international markets."

Analysts had expected Apple to earn $3.23 a share on $76.6 billion in revenue.

Shares of Apple rose modestly after the earnings were announced, then sagged as Cook and other executives talked on the post-earnings conference call with analysts. Having closed at $99.99, they slumped under $95 on Wednesday morning. The stock was above $120 as recently as November.

"[The] negative reaction after hours reflect[ed] … a huge shift in tone as AAPL sounded more susceptible to China macro versus 90 days ago," RBC Capital Markets analyst Amit Daryanani wrote.

Apple's relatively strong China performance isn't an anomaly or tied to any Asian enthusiasm for a quintessentially American brand. China's retail sales gains all last year were nearly five times the rate in the United States, where consumer spending has also been growing faster than the economy as a whole. According to Moody's Analytics, China's retail sales were up by double digits in every month of 2015.

According to Lee of IHS Global Insight, China's consumers have increased their spending at a fairly predictable pace in recent years, behaving much the same way when the investment side of the economy is growing faster than 10 percent as they are now, with overall growth reported at just under 7 percent in official statistics. Investors have openly questioned whether the official statistics exaggerate the health of China's economy.

The price of an iPhone is still stiff for Chinese consumers who make an average income of about $10,000 per three-person household, Lee said. But the average income of the top 20 percent of the population is about $23,000, making them the primary target of Apple's continued push into China. And consumers in China still have enough savings to keep consuming — though that could change if markets there keep gyrating, he said.

"It depends on the severity and the type of the slowdown," Lee said. A slow, steady decline in growth wouldn't be likely to spook consumers, but "if there's a banking crisis that crushes the economy, all bets are off."

Not all bets. Long-term prospects are bullish enough that Apple isn't planning to pull back on investing heavily in China, Cook said.

"The middle class in China was less than 50 million people in 2010, and by 2020 it's projected to be about half a billion," he said.

But in a possible sign that even Apple is hedging its bet on China, Cook's quickly changed the topic to India — which has a younger population and lower smartphone penetration than China, and where Apple boosted sales 38 percent.

"India is incredibly exciting," Cook said. "It's quickly becoming the fastest-growing BRIC country.''

—By Tim Mullaney, special to CNBC.com