May 11, 2017 10:00 am JST

Apple's prospects are strong, but suppliers aren't smiling

Component makers, gadget assemblers grapple with heavy dependence

DEBBY WU and CHENG TING-FANG, Nikkei staff writers

TAIPEI -- Apple's earnings once again beat estimates in the quarter just ended. Its profit margin is over 20% and its stock has gained some 30% since the beginning of the year, boosting its market cap to a historic high with billionaire investor Warren Buffett buying up shares in the company.

Shares in several suppliers have risen significantly over the past few months on high expectations for the iPhone 10th anniversary range due later this year. But not all have quite so much reason to smile, partly due to Apple's cost cutting.

In the January-March period, Apple got suppliers to slash the fees they charge for the iPhone 7 range by 10%-20%, according to Jeff Pu, an analyst with Taipei-based Yuanta Securities Investment Consulting. iPhones are Apple's main source of income, contributing about 63% to total revenue in the past quarter ended in March.

"No doubt pricing is a lot harder now since the [iPhone] volume growth is not as significant as the previous 5 years," a person familiar with the iPhone supply chain said, adding that automation is necessary though not the only solution to boost suppliers' profits.

The person also said that assemblers are now looking at what other services they may be able to provide Apple beyond manufacturing.

Both key iPhone assembler Hon Hai Precision Industry, also known as Foxconn Technology Group, and its smaller rival Pegatron saw a year-on-year drop in sales for 2016 as demand for Apple handsets fell.

Pegatron further reported weak results for the quarter ended in March and expects the current quarter to be muted, partly due to slow demand for the 4.7-inch iPhone 7.

Both companies relied on Apple for more than 50% of their sales.

Foxconn reported an operating margin of 5.46% in the quarter ended in December, a record high in nine years -- the ratio has rarely exceeded 4% for the world's largest contract electronics maker in recent times.

Pegatron seldom achieves a operating margin of over 3%.

Foxconn Chairman Terry Gou appears keen to remedy the heavy dependence on Apple with the acquisition of Japanese electronics conglomerate Sharp and attempts to branch out into other ventures, including investment in startups, robotics and cloud technology.

Still, the contributions from his new businesses are nowhere close to those from Apple.

Both Foxconn and Pegatron declined to comment.

Key parts makers may fare somewhat better, but in the case of Taiwan Semiconductor Manufacturing Co., there is anxiety over increasing dependence on Apple, even though the ties are part of the reason it has been able to deliver such strong results.

The world's largest contract chipmaker -- holding a 56% share of the global market -- makes core processors for iPhones and Apple has been its biggest customer since 2015.

The U.S. giant accounted for 17% of TSMC's record high revenue of 947.94 billion New Taiwan dollars ($31.4 billion) in 2016, up from 16% in 2015 and 9% in 2014.

TSMC Co-Chief Executive Mark Liu said in mid-April that, for the second consecutive year, the first half will be much slower than the second due to "premium phones seasonality."

He said the company would develop more customers to smooth out the issue.

Still, Apple's contribution to TSMC's revenue is likely to grow to some 21% for the whole of 2017, according to Mark Li, an analyst with Sanford C. Bernstein, as the company continues to monopolize orders for iPhone processor chips.

"In a world without Apple, up to 20% of TSMC's revenue would be gone this year and the revenue expansion since 2012 would nearly halve. Apple alone accounted for 42% of TSMC's revenue growth in this period," said Li.

But he cautioned the iPhone is now also the item in TSMC's portfolio that poses the most risks, and any disruption or delay in product shipments could hurt the chipmaker in the second half of 2017.

TSMC would do well to bear in mind what has happened to Imagination Technologies and Dialog Semiconductor, two of Apple's other chip suppliers.

Shares in chip designer Imagination Technologies, whose components are used in both iPhones and iPads, plunged more than 61% on April 3 after the British company said it would lose Apple orders by 2019 as the U.S. giant develops its own graphic processor technology.

About a week later, Dialog Semiconductor suffered a similar fate.

A key power management chip supplier, Dialog's shares closed down more than 15% on April 11 after an analyst said Apple is developing its own solutions and warned the German company may lose orders.

Neither stock has recovered to previous levels.

What is even more notable is Apple's ongoing tug-of-war with Qualcomm, which supplies baseband chips that allow handsets to make phone calls.

Apple has hit Qualcomm with lawsuits in China, the U.S. and the U.K. over patent licensing practices that allegedly charge for technologies the chipmaker does not own.

That came after the Federal Trade Commission in the U.S. sued Qualcomm for anti-competition practices. Qualcomm has also been fined in China and South Korea over similar charges, and is still under investigation in the EU and Taiwan.

In response, Qualcomm countersued Apple in April for hampering the performance of its chips so that components made by rival Intel would appear to perform just as well.

Qualcomm is now also reportedly trying to get a U.S. trade agency to ban imports of iPhones, a move that it declined to comment on.

Apple also declined to provide a comment for this story.

Asia300

Hon Hai Precision Industry Co., Ltd.

Taiwan

Market(Ticker): TAI(2317)
Sector:
Industry:
Electronic Technology
Computer Peripherals
Market cap(USD): 65,978.9M
Shares: 17,328.7M
Asia300

Pegatron Corp.

Taiwan

Market(Ticker): TAI(4938)
Sector:
Industry:
Electronic Technology
Computer Processing Hardware
Market cap(USD): 7,923.32M
Shares: 2,612.54M
Asia300

Taiwan Semiconductor Manufacturing Co., Ltd.

Taiwan

Market(Ticker): TAI(2330)
Sector:
Industry:
Electronic Technology
Semiconductors
Market cap(USD): 181,645M
Shares: 25,930.4M

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