China to become Apple's biggest market in 2 years: Analyst

Published Thu, May 28 20154:32 PM EDT

Evelyn Cheng @in/evelyn-cheng-53b23624 @chengevelyn

Apple's success story in China is just beginning. In fact, analysts say that Wall Street underappreciates how much of a driver that market is for the tech giant's stock. UBS analyst Steven Milunovich said in a Thursday note that "China has become a critical driver of Apple's results, providing over half of growth at above-average margins." Milunovich noted that as of the quarter ended in March, the iPhone maker now sells more smartphones in China than in North America. Apple also bucked a trend of declining total handset sales in the country by taking market leadership there. UBS has a "buy" rating on the stock with a $150 price target, a 14 percent upside from Thursday's price of $131.50 a share. FBR analyst Daniel Ives sees China leading to a 40 percent jump in Apple's stock to $185 a share. He expects that market to become the company's top geographic area by revenue in 2017 and account for almost 40 percent of total revenue in 2018. "We anticipate that Apple can capitalize on its current white-hot momentum in the region and penetrate further into the country with its strong product ecosystem and secular tail winds front and center," Ives said in a May 18 report entitled "Massive China growth opportunity still in the early days—maintain 'outperform.'" Greater China accounted for 29 percent of growth in the company's fiscal 2015 second quarter, up from 22 percent in the previous quarter. Revenue from the region increased 71 percent in the quarter from the same period last year. "They can double many times over, over many years to come, without saturating that market," said Alex Gauna of JMP Securities, which as a "buy" rating on Apple. "The success in China is the attractive valuation of the stock," he said. Like UBS, JMP has a price target of $150 a share. The iPhone captured 12 percent of smartphone market share in China in the first quarter of calendar 2015 and is on track to top that market later this year, Strategy Analytics said. Competition from Xiaomi, long called the "Apple of China" is on the wane, the data showed. Key to Apple's success in China is its stores. The company plans to nearly double the number of locations to 40 by the middle of next year. Apple has more than 280 stores in the United States. "That is their goal, to replicate the success they've seen in North America in the critical, critical market (of China)," said Brian Blair of Rosenblatt Securities. "What's really important is having a place where people can go." In a country where appearances are essential, these stores often outdo already impressive U.S. retail venues. The $750 billion market-cap company put its Shanghai store entrance at the bottom of a glass cylinder. The Hangzhou store, which opened this January, features a floating second floor in a tall glass structure designed by Foster + Partners. Read More Apple bears may be missing one big thing "They can afford what it's going to take to build a user base for all Apple products, not just phones—Macs, the watch," Blair said. Besides Apple's ability to tap into China's strong consumer base, the iPhone maker is well-positioned in the country as a major manufacturer. Primary suppliers include Hon Hai/Foxconn Technology , the world's largest electronics manufacturer, which has 25 sites in China . Read More Apple's China working conditions not so bad: exec As a provider of jobs and revenue, Apple has an edge over foreign and domestic competitors in bargaining with local authorities, analysts said. "As important as China is to consumption, Apple is driving expansion," JMP's Gauna said. To be sure, an unfriendly change in Chinese government policy may pressure the company. As the country wants to become an innovation leader rather than simply a manufacturing base, political initiatives such as the "Made in China 2025 Strategy" increase risks for Apple, Jamian Ronca Spadavecchia, president of global risk research firm Oxbow Advisory, said in an email. "Through policy and regulatory constraints, companies such as Apple will increasingly be pressured to shift more innovation and design aspects to China," he said. Increased overseas exposure of Apple's intellectual property could make it more vulnerable to theft. For now, the massive Chinese consumer base that spurred the success of Alibaba will continue to support sales of Apple products—at high margins. FBR noted operating margins of about 37 percent in fiscal 2014. "We believe strong growth from the iPhone will continue to boost profitability," Ives said. He and other analysts also noted partnerships with local phone carriers, beginning with China Mobile last year , will help Apple expand its reach in the country. Read More Apple crowned world's top brand—but watch Alibaba "It's the most critical market in the future of electronics and Apple recognizes that," Blair said.

People experience in new Apple Store at Jiefangbei in Yuzhong District on January 31, 2015 in Chongqing, Sichuan province of China.

ChinaFotoPress | Getty Images

Apple's success story in China is just beginning.

In fact, analysts say that Wall Street underappreciates how much of a driver that market is for the tech giant's stock.

UBS analyst Steven Milunovich said in a Thursday note that "China has become a critical driver of Apple's results, providing over half of growth at above-average margins."