Here's How The Looming Trade War Will Hurt Apple

With a trade war brewing between the United States and China, investors have been anxiously waiting to see how the back and forth between Washington, D.C. and Beijing will play out. It's difficult to know how an all-out trade war would impact investors, but the uncertainty weighs heavy on the market, as Wall Street despises uncertainty.

This article originally appeared in The Motley Fool.

One company that has thus far been spared the effects of the escalating trade tensions is Apple (NASDAQ:AAPL). However, the company's inexorable links to China are clear: The majority of Apple's manufacturing operations are located in the Middle Kingdom, and the country represents a significant market for Apple's products.

With such strong ties to China, it was inevitable that Apple would eventually feel the impact of the growing tariffs that are being slapped on imports on both sides of the Pacific. In a recent filing with the U.S. government, Apple says a day of reckoning is coming.

Hoping that "calm heads prevail"

In its third-quarter financial report, Apple reported revenue of $9.55 billion from Greater China, up 19 percent year over year, and representing 18 percent of Apple's total sales. During its quarterly conference call, Apple CEO Tim Cook said it was the "fourth consecutive quarter that we've had double-digit growth in Greater China," producing "double-digit growth from services, to iPad, to iPhone, and to our Other Product category in which the [Apple] Watch did extremely well, and so there are lots of good things happening there."

At the time, Cook pointed out that there were a number of tariffs at various levels of implementation, saying the company had yet to be feel the pinch — at least thus far. "I am optimistic that the countries will get through this. And we are hoping that calm heads prevail," Cook said.

Putting on a brave face

That early optimism has given way to a fair degree of concern. In a filing with the U.S. Trade Representative, Apple told the Trump administration that the most recent $200 billion in proposed tariffs would affect "a wide range of Apple products" — calling out the AirPods, Apple Watch, and the Mac Mini computer.

Apple said that "all tariffs ultimately show up as a tax on U.S. consumers." The latest round would effectively impose a 25 percent tax on the company's finished products, or on the components that are used to make them. Any potential increase in costs would either be passed on the customers, resulting in lower sales, or absorbed by Apple, pummeling its bottom line.

Hitting Apple where it hurts

It's important to note that Apple's Other Products category, which includes the Apple Watch and AirPods, has been the company's fastest growing segment, up 37 percent year over year in Apple's third quarter. In its conference call to discuss the results, Cook highlighted "wearables" — a subset of its Other Products — as an example of the company's continuing success:

Wearables, which comprises Apple Watch, AirPods, and Beats, was up over 60 percent year-over-year with growth accelerating from the March quarter. Our wearables revenue exceeded $10 billion over the last four quarters, a truly remarkable accomplishment for a set of products that has only been on the market for a few years. Apple Watch delivered record June quarter performance with growth in the mid 40 percent range.

It's telling that each of those products was mentioned in Apple's filing — the devices seeing the fastest growth could be hit the hardest.

It could get worse before it gets better

With the recent proposed tariffs set to impact Apple's fastest growing product category, it's easy to see why Apple would "urge the Administration not to apply tariffs on these" products. The filing went on to say "it is difficult to see how tariffs that hurt U.S. companies and U.S. consumers will advance the Government's objectives. ... We hope, instead, that you will reconsider these measures and work to find other, more effective solutions."

Unfortunately, the situation will likely get worse before it gets better. President Donald Trump said late last week that he was prepared to escalate the trade war even further if necessary, imposing duties on virtually all imports from China. That would result in another $267 billion in tariffs, Trump said, on top of the $200 billion in potential duties addressed in Apple's filing and the $50 billion already enacted earlier this year. The total proposed tariffs, which now exceed $517 billion, would top the $505 billion in goods imported from China in 2017.

This was likely not the news that Apple — and investors — were hoping to hear.

Danny Vena owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.