Apple's Asia Supply Chain

When it comes to products like iPhones, iPads and iWatches, only one name comes to mind: Apple . It is an underappreciated fact that none of these products would be available without Apple’s extensive network of suppliers. In this article, I will take an exhaustive look at Apple’s massive Asian supply chain, with special emphasis on iPhone 6 and iWatch suppliers. These overlooked and highly volatile small-cap Asian stocks offer investors unique ways to speculate on the success of Apple’s product line. I will provide speculators with a list of possible strategies and individual investment.

Apple made a huge splash during its product launch event on September 9th, when it announced two iPhones, the iPhone 6 and 6 Plus (with 4.7” and 5.5” displays respectively). The surprise came from the announcement that Apple would enter the wearables market with its new line of watches dubbed the iWatch.

Furthermore, Apple announced the introduction of a new NFC enabled payment service, dubbed “Apple Pay”. It will initially be available for iPhone6/6 Plus users in the US, and later on for iWatch costumers. Although the Apple Pay system is beyond the scope of this article, it is worth noting that Apple Pay functionality could further increase consumer loyalty for the iOS ecosystem, which could prove to be very profitable for Apple in the long term.

A detailed look at the iPhone 6/6 Plus and the iWatch

For all the technophiles out there, I have decided to provide a detailed overview of the technical specifications of the latest iPhone 6/6 Plus models versus the previous iPhone 5 models, courtesy of UBS (Figure 1).

Figure 1: Detailed technical specifications of the iPhone 6/6 Plus and the iPhone 5S/5C (Source: UBS)

The hardware specifications for the iPhone 6/6 Plus were in line with analyst expectations, the following points are noteworthy. Firstly, the iPhone 6 Plus boasts a much larger 5.5 inch, 1920x1080 resolution Retina 400ppi screen compared to the iPhone 6, which has a 4.7 inches 1334x750 resolution 326ppi Retina screen. As the price difference between the two phones is only $100, there is a considerable chance that consumers will opt to buy the iPhone 6 Plus instead of the standard iPhone 6 model. This will logically cannibalize demand for the standard iPhone 6 model. Such demand cannibalization might have a significant effect on the profitability of certain suppliers, which we will discuss in detail later in this article. Secondly, at 5.5’’ the iPhone 6 Plus screen is so large that it might cannibalize demand for iPads, especially the smaller iPad Mini models. This might have negative consequences for suppliers with high exposure towards iPad production. Thirdly, the latest iPhones have a much higher NAND flash memory capacity at 128GB for the high-end of both models. This “free” NAND memory capacity is double that of the previous iPhone 5S. This increased flash storage capacity bodes well for suppliers of NAND memory. Lastly, the latest iPhones will not have sapphire coated displays, which is quite a disappointment for relevant suppliers.

Considering the specifications of the iWatch (Figure 2) we can conclude the following: although many of the iWatch’s technical details are still unknown, most equity analysts were impressed with the announced haptic feedback and health tracking capabilities. The iWatch will be software compatible with the iPhone 6 and iPhone 5 models, which indicates a potential customer base of 200 million people. The iWatch will also incorporate Apple Pay functionality, which further increases the attractiveness of the product for potential consumers. At a price of $349 for the standard model, the iWatch is clearly a discretionary product and not a “must-have”. Yet with Apple’s exceedingly loyal user base, strong brand reputation and the iWatch’s impressive functionality compared to other smartwatches currently available, potential demand for the iWatch could be quite strong. This might have positive ramifications for suppliers of haptic feedback and health sensors.

Figure 2: iWatch specifications versus other smartwatches currently available (Source: Phandroid.com)

Deciphering Apple’s massive supply chain

Now that we have a clear overview and understanding of the technical specifications of the new iPhone and iWatch, we can analyze the potential consequences these new products might have for Apple’s suppliers. In order to do this we must first identify the relevant publicly traded suppliers within the massive jungle that is Apple’s supply chain. The sheer size and complexity of the Apple supply chain is nicely illustrated in the following illustration, courtesy of Citi Research (Figure 3).

Figure 3: Apply supply chain flow chart as of July 15th, 2014 (Source: Citi Research)

In our case we only want to focus on the suppliers with a significant exposure towards the iPhone, iPad and iWatch. More precisely, we want to know what specific parts each company supplies. The following table provides a detailed overview of all relevant suppliers and their relevant specialty (Figure 4).

Figure 4: Extensive list of Apple supply chain companies with associated specialties (Source: UBS)

The extensive list of companies in Figure 4 needs to be analyzed further in order to gauge the potential impact Apple’s newest products will have. Trying to compare all of these companies in unison is akin to comparing apples and oranges. Some of these companies are highly leveraged towards Apple, while others have a highly diversified stream of revenues from different clients and are thus less geared towards Apple products. A detailed breakdown of supply chain company exposure towards Apple is illustrated in the following table (Figure 5). 

Figure 5: Asian supply chain exposure towards Apple and the iPhone (Source: HSBC)

Now that we have an overview of Apple supply chain companies, including their associated specialties and relative revenue exposure, we can begin the task of analyzing these companies in an efficient manner. In doing so we can highlight individual stocks and devise strategies to profit from potential iPhone, iPad and iWatch sales. The following paragraphs will provide readers with a list of possible strategies in order to capitalize on these various trends within Apple’s product ecosystem.

Strategy #1: iPhone 6 Plus cannibalizing iPhone 6 demand

When looking at Figure 5, we can see that the assembly companies Hon Hai (stock symbol: 2317, Taiwan) and Pegatron (stock symbol: 4938, Taiwan) have very high revenue exposure towards Apple and iPhone sales. Therefore these companies are an extremely leveraged play on iPhone sales.

If we look closer at both companies we can see a crucial difference between the two. According to a HSBC report1, Hon Hai is the sole assembler of the iPhone 6 Plus, and it provides 70% of the assembly orders for the iPhone 6. The remaining 30% of the iPhone 6 assembly is carried out by Pegatron. This crucial difference means that Hon Hai is a leveraged play on the iPhone 6 Plus, while Pegatron is a leveraged play on the standard iPhone 6 model.

The aforementioned distinction between Hon Hai and Pegatron creates an interesting opportunity for the following reason: the price gap between the iPhone 6 and 6 Plus is narrow at only $100, while the 6 Plus offers a superior display, much longer battery life and optical image stabilization on the camera. As such, many potential buyers may opt to pay the extra $100 to buy the superior iPhone 6 Plus. This scenario is especially relevant when one considers that Apple caters to an upper-class of prosperous consumers, who generally will not mind paying slightly more for a superior product.

This creates upside potential for Hon Hai, while simultaneously generating downside risk for Pegatron. The following English proverb summarizes the situation perfectly’: “one man's loss is another man's gain". An easy way to capitalize on this potential divergence between Hon Hai and Pegatron is through a simple spread trade. Investors can buy Hon Hai shares while simultaneously shorting Pegatron. This trade is attractive as both stocks have seen a massive ramp-up in their stock prices over the past 12 months (Figure 6). As the stock chart in Figure 6 illustrates, the aforementioned divergence between Hon Hai (green line) and Pegatron (yellow line) seems to be playing out already.

Figure 6: Hon Hai and Pegatron stock performance (1-year timeframe)

Strategy #2: iPhone 6 Plus cannibalizing iPad mini demand

As mentioned earlier, the iPhone 6 Plus has a massive 5.5 inch, 1920x1080 resolution Retina 400ppi screen. Therefore, the iPhone 6 Plus can be considered a “phablet” (a mobile phone/tablet hybrid), as it boasts all of the functionality you would find in a tablet. Because of these properties there isa very real risk that demand for the iPhone 6 Plus will cannibalize demand for iPads, and in particular for the iPad mini model with Retina display.

The case for demand cannibalization between the iPhone 6 Plus and the iPad mini (with Retina display) is quite realistic if we take a closer look at the technical specifications of both products. Firstly, the price gap between the most high-end iPhone 6 Plus model and the iPad mini (+ Retina display) is quite narrow. The iPhone 6 Plus with 128GB of memory sells at $949, while an iPad mini with the same memory storage sells at $829.

This price gap is further narrowed when one considers that the iPhone 6 boasts superior hardware compared to the iPad mini. For example, the 6 Plus has the newest A8 processor chip, making it faster than the iPad mini with its older A7 chip. The 6 Plus also has a superior camera and incorporates the latest TouchID and Apple Pay functionality. Lastly, there is the simple fact that the iPhone 6 Plus has phone functionality because of its smaller, lighter and more pocketable form factor.

Unless you are a consumer who has large amounts of cash to burn, you will either buy the iPhone 6 Plus or the iPad mini but not both. Because of the aforementioned reasons, the case for buying an iPhone 6 Plus at the expense of the iPad mini is quite strong. This creates a comparable situation to the one mentioned in the previous paragraph. Specifically, this means that there might be increased upside potential for companies geared towards the iPhone 6 Plus, at the expense of companies with a high exposure towards iPad production. In our case, this means that the assembly company Hon Hai might be the beneficiary, while companies such as Casetek (stock symbol: 5264, Taiwan), Career (stock symbol: 6153, Taiwan) TPK (stock symbol: 3673, Taiwan), G Tech (stock symbol: 3149, Taiwan) and PanAsialum (stock symbol: 2078, Hong Kong) suffer. An interesting way to play this scenario is through a spread trade between Hon Hai and any or all companies with high iPad exposure. This means that investors can opt to buy Hon Hai shares while shorting shares of Casetek, TPK, G Tech and PanAsialum.

Looking at the comparative stock chart for these companies (Figure 7), we can see that this trend has largely played out already for companies like TPK, G Tech and PanAsialum, as their stock prices have been utterly crushed over the past year. Yet there is still ample room in this spread trade when it comes to the shares of Casetek (beige line), which up until now has bucked the trend plaguing the other iPad suppliers. As Casetek is heavily exposed to iPad sales, one might argue that its shares could fall in a similar fashion to those of the other iPad suppliers. Shorting Career shares (blue lines), is somewhat complicated by the fact that the company also has iPhone and possible iWatch exposure, which might nullify the potential negative impact of decreasing iPad sales.

Figure 7: Hon Hai, Casetek, Career, TPK, G Tech and PanAsialum stock performance (1-year timeframe)

Strategy #3: Buying memory suppliers.

As readers can deduce from the iPhone technical specifications presented in Figure 1, the latest iPhone 6 offers consumers double the NAND memory storage capacity for the same price, compared to the previous iPhone 5S. Apple decided to exclude models that provide 32GB of storage, opting instead for 64GB storage in the iPhone 6 ($749). This 64GB storage in the iPhone 6 sells at the same price as the previous iPhone 5S 32GB model. The most expensive iPhone 6 model ($849) comes with 128GB of storage, while the comparable iPhone 5S model only came with 64GB of memory. In essence consumers get double the amount of NAND memory for “free”.

This increased NAND memory storage density is quite beneficial for Apple’s memory suppliers. This is even more pronounced whenwe consider the historical iPhone storage distribution (Figure 8). As can be seen, 32GB models represent roughly 30% of sales in previous iPhone models, while 64GB models represent nearly 10% of sales. But most importantly, nearly 20% of consumers still have older iPhone models which only have 8GB of storage.

Figure 8: iPhone storage historical survey mix (Source: UBS)

This massive user base with older 8GB iPhone models consists of the people who are most likely to opt for an upgrade to the newest iPhone 6 models, considering the age of their device and their expiring phone subscriptions. This means that nearly 20% of users will have to switch to iPhone models with at least 16GB of storage. The same also holds true for holders of 32GB and 64GB iPhone 5S models. These users will probably opt for the newest iPhone 6 model which sells at the same price, but has double the storage. As a result, nearly of 50% of Apple’s iPhone user base might switch to newer iPhone models with double the NAND memory. This upgrade cycle, which excludes first-time iPhone buyers, will generate enormous demand for NAND storage suppliers.

An obvious way to capitalize on this trend is to buy shares of companies which supply Apple with NAND memory for iPhones. In this context, the following two companies stand out: SK Hynix Inc. (stock symbol: 000660, South Korea) and Inotera Memories Inc. (stock symbol: 3474, Taiwan).

An inspection of the comparative stock chart (Figure 9) shows the massive surge these stocks have experienced over the past twelve months. During this period Inotera shares (yellow line) have soared with a massive 165%, while SK Hynix shares (green line) are up nearly 60%. These stocks have declined somewhat inthe past few months. Considering the very positive ramifications that the increased iPhone 6 NAND memory density might have on these companies, investors could opt to buy these stocks, now that they have sold off a bit from the peaks seen in July.

Figure 9: Inotera Memories Inc. and SK Hynix Inc. stock performance (1-year timeframe).

Strategy #4: Buying iWatch suppliers

Apple CEO Tim Cook surprised technology pundits when he announced the new iWatch at the Apple launch on September 9th. The announcement certainly made a splash within the Tech world, as it marks Apple’s entry into the wearables market.

Although many of the iWatch’s technical details are still unknown, most equity analysts were impressed with the features announced up until now. The iWatch is clearly superior to all other smartwatches currently available on the market, as it comes with a sapphire covered P-OLED screen, haptic feedback, a newly designed user interface, and integrated health tracking capabilities. This is further reinforced by its compatibility with Apple’s iOS ecosystem, its Apple Pay functionality and the army of WatchKit developers eager to create all-new exclusive apps and functionalities for the iWatch.

The iWatch will be software compatible with the iPhone 6 and iPhone 5 series, which indicates a potential customer base of 200 million people, according to Apple CEO Tim Cook. Although we should always take statements from a company CEO’s with a grain of salt, it does indicate a massive consumer base for the new iWatch. Even if only a small percentage of existing iPhone users opts to buy the iWatch, the demand will be massive. In a recent UBS report, analysts forecast that iWatch sales might follow the same historic pattern as that of the iPad sales (Figure 10). The reasoning behind this assumption is that the iWatch is more of a discretionary purchase, and will therefore follow a slower sales trajectory than that of iPhones. However, it will be comparable to the sales trajectories of iPads, which are also considered discretionary products. Although the iWatch is not a must-have, the Apple brand is powerful and user loyalty is strong.

Figure 10: Cumulative unit sales of iPads, iPods and iPhones since launch and UBS estimates for Apple iWatch (Source: UBS)

Odds are high that many existing iPhone users may opt to buy the iWatch out of curiosity and because of its strong brand apparel (“coolness” factor). UBS indicates that over 10% of eligible users might opt to buy the iWatch, which in their view is a “conservative” estimate. If these estimates prove to be even remotely accurate, companies within the iWatch supply chain stand to benefit enormously.

The largest potential beneficiaries are the companies which supply Apple with the vast amount of sensors required for the iWatch. These include a wide array of sensors for measuring health markers as well as haptic feedback technology. Key companies within this section of the supply chain are AAC Technologies Holdings Inc. (stock symbol: 2018, Honk Kong) and Advanced Semiconductor Engineering Inc. (short name: ASE) (ADS shares trade in New York under the symbol ASX). Another interesting company is Quanta Computer Inc. (stock symbol: 2382, Taiwan) which is rumored to be the sole assembler of the iWatch.

An analysis of the stock chart (Figure 11) shows that shares for these companies are up roughly 20-30% over the past twelve months. Given the strong positive fundamentals for sensor suppliers like AAC and ASE, investors could opt to purchase these shares, not only as a play for potential iWatch sales, but as a longer-term strategy to capitalize on the wearables market, which will use ever increasing amounts of sophisticated sensors.

Figure 11: AAC Technologies, Advanced Semiconductor Engineering and Quanta Computer stock performance (1-year timeframe).

Strategy #5: Buying Apple camera lens suppliers

According to the latest news release by Apple, the company sold a whopping 10 million units of the iPhone6/6 Plus during the opening weekend (Figure 12). In doing so, sales for the iPhone 6/6 Plus eclipsed all previous iPhone models with regards to opening weekend sales. 

Figure 12: iPhone opening weekend sales (Source: Bloomberg Business Week)

One of the reasons for this is the exceedingly good camera that comes with the iPhone 6. According to tests conducted by the highly respected camera sensor rating company DxO Labs, Apple’s iPhone 6 and 6 Plus are the best camera phones currently available. This highly positive review coupled with exceedingly strong iPhone sales bodes well for supply chain companies with exposure towards the new iPhone camera.

In this respect camera lens suppliers such as Largan Precision Co. Ltd. (stock symbol: 3008, Taiwan) and Genius Electronic Optical Co. Ltd. (stock symbol: 3406, Taiwan) stand to benefit strongly if sales for the new iPhone continue on their record-breaking trajectory. This is even more the case when we consider the fact that both these companies are enormously leveraged toward iPhones sales (Figure 13).

Figure 13: Largan and Genius sales exposure towards iPhones (Source: Deutsche Bank)