Why India’s Market May Not Be The Next China For Apple
Contributor since 2013 / 6987 Followers
Summary:
- Apple has recently turned its focus towards India as a key growth driver, with management emphasizing its optimism about the Indian market’s potential.
- India’s demographics, economic growth, and infrastructure improvements paint a positive picture of the country’s future and investment opportunities.
- However, India’s market is not directly comparable to China due to structural challenges like literacy rates and language diversity, which create a more complex environment for businesses like Apple.
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Last month, in our published article, we expressed optimism about Apple (NASDAQ:AAPL) and its potential for growth in search and financial services. Since then, Apple has posted better-than-expected Q1 earnings, which is not surprising given the company’s history of strong execution. However, what caught our attention was Apple’s emphasis on India as a key growth driver this quarter, a trend we have observed lately. In this article, we will examine the opportunities and risks associated with Apple’s expansion into the Indian market, along with an updated analysis of the company’s financials and valuation.
Q1 Earnings Call: India Discussion
Apple’s management has recently turned their focus towards India, as evidenced by their numerous favorable mentions during the Q1 earnings call. This emerging market has been a notable (though small in absolute size) contributor to Apple’s stronger-than-expected Q1 results, with the company noting that India, Indonesia, Turkey, and UAE have doubled year-over-year (y/y) in the quarter.
Tim Cook, Apple CEO, expressed excitement over the opening of Apple’s first two retail stores in India, in Mumbai and Delhi. He was delighted by the enthusiasm of customers, developers, creatives, and team members he interacted with during his visit.
Apple has been expanding its operations in India to serve more customers, including launching the Apple Store online three years ago and partnering with channel partners in the country. Cook believes that India is at a tipping point, with a growing middle class that presents a massive opportunity for Apple to convince them to buy iPhones and other Apple products.
However, when asked if India is like China a decade ago, Apple’s management acknowledged that each country has its unique journey, and direct comparisons should be avoided. In our view, management is tempering expectations that India could be the next China. Nevertheless, the company is optimistic about the potential of the Indian market.
In our view, Apple’s management has identified India as a crucial growth driver for the company. The Indian market’s dynamism, along with the growing middle class, presents a substantial opportunity for Apple to expand its customer base and increase sales in the region. As Apple continues to invest in its operations in India, the company’s commitment to this market will likely contribute to its overall growth in the coming years. Investors should closely monitor Apple’s progress in India, as it could have a significant impact on the company’s future performance and valuation.
India’s Promises
The bullish case for India is primarily driven by its demographics. This year, India is expected to officially surpass China as the world’s most populous country, boasting a younger population than China and the West. While India’s economic influence has been limited due to its relatively low income levels, the nation is steadily becoming more prosperous. According to the International Monetary Fund, India’s annual economic growth is projected to average ~ 6% this year and next, making it the fastest growing among 30 major economies and resuming a two-decade trend of strong growth.
In recent years, India has made significant strides in infrastructure development and economic progress. Last year, India overtook the UK as the world’s fifth-largest economy in current dollar terms and is poised to potentially tie with Germany for fourth place by 2025. Between 2014 and 2019, national highway kilometers in India expanded by 45%. Under Prime Minister Narendra Modi’s leadership since 2014, the number of airports has doubled, rural roads have increased by 85%, and electricity plant capacity has risen by 66%, leading to a significant decrease in blackouts.
These developments paint a positive picture for India’s future, with strong demographic trends and rapid economic growth driving the nation’s progress. As India continues to build on its infrastructure and improve living standards for its citizens, the country is expected to gain greater global economic influence and present promising investment opportunities for businesses and investors alike.
A History of Undue Optimism
As astute observers of the market, we believe the West has a long history of overestimating India and underestimating China. This is primarily because India, as a democracy with English as one of its official languages and a long engagement with the West, is easier for Western observers to understand. The West often hopes for India’s success as a counterbalance to the rapidly growing power of China, which remains challenging to comprehend for many.
However, the popular narrative of India’s booming economy has not always been accurate. Economist Arvind Subramanian pointed out that India’s economic growth faltered after the 2008 global financial crisis and stalled completely after 2018 due to its emphasis on self-reliance and defects in its policymaking process. While India’s growth has been rapid in the past two years, this is largely a statistical illusion, as the country experienced one of the worst GDP contractions during the first year of the pandemic among large countries.
Compared to 2019, India’s current GDP is just 7.6% larger, far short of the 7% annual growth rate considered its potential. The industrial sector has fared even worse, with industrial production barely above 2019 production. Forward-looking indicators are not encouraging as private sector projection completions have again fallen off. Despite all the talk about India as the investment destination of choice, overall foreign direct investment has stagnated for the past decade, remaining around two percent of GDPDespite the hype around India as an investment destination, foreign direct investment has stagnated for the past decade, remaining around 2% of GDP.
Many foreign firms have faced challenges in the Indian market. Investors may recall that Google (GOOG) (GOOGL) has for many years faced regulatory challenges and competition from India’s very capable startup community, a headwind it continues to face today. In 2019, Walmart (WMT) complained to the US government about unfavorable regulations for the company, and warned that it may even hurt US-India trade ties. In 2021, the Financial Times reported that Vodafone’s (OTCPK:VODAF) Indian venture, Vodafone Ideas, is on the verge of collapse after losing market share to rivals such as Mukesh Ambani’s Reliance Jio after a fierce price war. General Motors (GM) continues to struggle to exist in the Indian market after they stopped selling cars in 2017 due to low volumes, as they are now embroiled in a lawsuit by a union for illegal termination of employees and non-payment of wages. Even Amazon (AMZN) has struggled in India, recently announcing a broad-based retreat from India after deploying over $7 billion in the country.
These lessons show that Apple will likely face regulatory and competitive challenges in India that should not be underestimated, especially as the company ramps up iPhone production in India. Nevertheless, although India is a small % of Apple’s revenue today, it is the second-largest smartphone market in the world by volume, according to IDC, so one can understand that the company must try to establish itself in the India market despite these potential challenges.
Manufacturing Issues
Although Apple has seen rapid growth in India from a low base and is excited about its market, Apple is facing challenges in its bid to increase production in India as it seeks to reduce its manufacturing reliance on China. At a casings factory in Hosur run by Indian conglomerate Tata, only about 50% of components coming off the production line are in good enough shape to be sent to Foxconn, Apple’s assembly partner for building iPhones. This yield is far from Apple’s goal of zero defects. While the factory is working towards improving efficiency, the road ahead is long.
The company has been sending product designers and engineers from California and China to factories in southern India to train locals and establish production, mirroring the strategy it implemented in China two decades ago. Although Apple has been producing lower-end iPhones in India since 2017, the recent production of flagship models within weeks of their launch in China marks a significant milestone. However, recent experiences have highlighted the challenges Apple faces in India.
This may be the harbinger of things to come as Apple could face an Amazon-like failure in that country.
India Is Not Like China
During the Q1 call, Evercore analyst Amit Daryanani asked if Apple sees India today as comparable to China “maybe a decade or so ago” and if “that is a reasonable ramp to think India would have.” However, we believe the market should not harbor illusions that such a ramp is possible due to the country’s significant structural issues. We will highlight a few key ones here.
First, China’s adult literacy rate in 2010 was over 95%, while India’s literacy rate today is 77.7%, approximately the same as China’s literacy rate in 1990, over 30 years ago. In fact, this issue is even more severe than it appears, leading us to a second structural issue: India is a much more heterogeneous and, thus a more complex market.
While China’s literacy rate is measured in Chinese (Hanyu), only 57% of India’s population speaks its most popular language, Hindi, which includes non-native speakers. Additionally, only 10-11% of the population can speak English, with most being non-native speakers.
These factors make it difficult to directly compare India’s growth trajectory with that of China from a decade ago. The differences in literacy rates, language diversity, and social heterogeneity create a more complex environment for businesses like Apple to navigate in India. Therefore, it would be unwise to assume that India will follow the same growth ramp that China experienced without addressing these structural challenges.
Financial & Valuation
Note: All historical data in this section comes from the company’s 10-K filings and all consensus numbers come from FactSet.
Apple’s recent quarterly earnings results showcased the company’s resilience as it managed to beat consensus estimates for EPS by 6.4% at $1.52, despite facing a 2.5% year-over-year decline in revenue, which amounted to $94.8 billion. The sell-side consensus expects a contraction of 1.5% in revenues this fiscal year, followed by a 7.1% growth next year, reaching $415.8 billion.
In the past three fiscal years, Apple’s EBIT margin expanded by 5.7% points, from 24.6% to 30.3%. Though a contraction of 116 basis points to 29.1% is expected this fiscal year, an expansion of 18 basis points to 29.3% is forecasted for the following fiscal year. Apple’s strong return on invested capital of 58.2% demonstrates the company’s efficiency in deploying its capital to generate returns.
Over the past three years, Apple has spent 2.3% of its revenue on share-based compensation (SBC) while reducing diluted outstanding common shares by 9.6%. This has led to an impressive EPS growth with a CAGR of 27.1% over the past three fiscal years. Consensus forecasts predict a decrease of 2.7% to $5.95 in EPS this fiscal year, followed by an 11.0% increase to $6.60 the next year.
Apple’s stock currently trades at a premium compared to the S&P 500 across various valuation metrics, including an EV/Sales premium of 198.9%, an EV/EBIT premium of 42.4%, a P/E premium of 58.7%, and an FCF premium of 31.1%. The stock has outperformed the broader market with a 4% point advantage over the S&P 500 and is trading 14.7% above its 200-day moving average. The low short interest of 0.7% reflects positive investor sentiment.
Apple remains an attractive investment opportunity despite the expected contraction in revenues and EBIT margin this fiscal year, which is mainly due to product cycles and weakening macro and not a reflection of weak fundamentals, in our view. The company’s solid balance sheet, with a net cash position of $56,718 million, strong return on invested capital, and efficient capital allocation strategy provide a foundation for continued growth. While the stock trades at a premium compared to the S&P 500, we believe that Apple’s innovative product lineup and expanding services segment, as well as its future growth prospects, justify the valuation. Investors should closely monitor the company’s performance in the coming quarters and consider Apple as a valuable addition to their portfolios.
Conclusion
While we maintain a Buy rating on Apple and appreciate the company’s strong execution and growth potential, we do not believe investors should get carried away with their expectations for India, a market that has historically disappointed. India’s unique structural challenges, such as lower literacy rates and language diversity, make it difficult to directly compare the country’s growth trajectory with that of China from a decade ago. As a result, investors should be cautious and closely monitor Apple’s progress in the Indian market, as it could have a significant impact on the company’s future performance and valuation.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
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