risk that Apple Inc. faces with respect to its international economic exposure. Apple designs its products in the United States, manufactures them in China and then sells them all over the world. In order to analyze this exposure, a number of steps will be undertaken. The first step will be to provide an overview of the business, what its foreign exchange exposure is, and how the company manages that foreign exchange rate risk. The subsequent sections will discuss the degree of exposure that the company has to other forms of international risk -- economic risk in particular. There will be an industry and company analysis to provide a framework for this discussion of risk. There is also going to be a discussion of how the company manages the different risks to which it is exposed, and what the analysts' views of this exposure are as well. The final component of this report will consist of a scenario analysis, wherein Apple's business will be evaluated for robustness in best-, worst- and most likely-case scenarios. Conclusions will be drawn from all of this research and analysis with respect to how well Apple is managing its international risk.
Foreign Exchange Rate Risk
Foreign exchange rate risk is defined as the risk that arises from the fluctuations in foreign exchange rates vs. The home currency. There are two forms of foreign exchange rate risk, transactional and translational. Translational risk arises when the company exchanges currencies. The company typically will either gain on these transactions or lose, depending on which direction the currency has moved. The volatility of these currency movements is where the risk arises. Translational risk occurs in translating back foreign earnings to the home country income statement. This type of risk is more difficult to hedge and therefore is often not addressed by companies. This report will focus on transactional risk.
Apple's foreign currency risk mainly arises from the goods it sells, but there is also some indirect risk that it faces with its suppliers. The direct risk arises when selling in foreign markets, with the price of goods denominated in foreign currencies. At the retail level, Apple aims to achieve pricing parity worldwide -- the price of an Apple product in a foreign currency will be the equivalent of that product's USD price on the domestic market. The company therefore is exposed to risk when it attempts to repatriate earnings from foreign countries back to the United States. There is significant exposure to the pound, the euro, the yen, CAD, AUD, HKD, SGD, as well as the won and yuan. Exposure to Asia-Pacific currencies has increased significantly in recent years. Since the company is especially susceptible to gains in the USD, the currencies most at risk are ones that are prone to weakness against the USD - in recent the years the macroeconomic situations make the EUR, GBP and JPY the most at-risk currencies; the CAD, yuan and AUD are among the less at-risk currencies that are generally appreciating against the USD.
In the Form 10-K, Apple specifically mentions that it "uses derivative instruments, such as foreign currency forward and option contracts, to hedge certain exposures in foreign currency exchange rates" (p.19). The company also noted that in 2011 it faced higher premium expenses on such hedges. Under Item 7A (p.40), the company notes that it "regularly reviews its foreign exchange forward and option positions…in conjunction with its underlying foreign currency and interest rate exposures." The company notes that it is a "net receiver of currencies other than the U.S. dollar" and therefore is particularly prone to strengthening of the U.S. dollar. The company also notes that it might at some point be forced to adjust local currency pricing in response to significant volatility in foreign currency exchange rates. Apple normally hedges its positions for up to six months, and chooses only to hedge certain exposures, leaving other unhedged (p.40). The company does not specify the reasons it does this. There is also a degree of indirect exposure in terms of the economic conditions under which its suppliers operate. While Apple pays its suppliers in dollars, its suppliers typically pay their expenses in yuan, and inflation in China can dramatically affect the ability of Apple suppliers to meet the prices the company sets profitably. There is risk that these pressures will affect Apple's ability to bring its products to market at the price points it wishes to set.
In general, Apple's foreign exchange rate management program is in line with industry norms. The company understands its exposure specifically, and takes steps to measure that exposure and address it through a variety of hedging mechanisms. Apple's actions in this regard are fairly normal, and the company does not appear to have suffered any adverse effects arising from its foreign exchange rate risk as the result of this program.
General Economic Analysis
This section will outline the effects that the general economic conditions are expected to have on the risk that Apple faces. The economic environment will be outlined, the risks analyzed, and conclusions made with respect to Apple's strategy to address these risks.
Apple is a differentiated provider, and prices its products at a premium. These superior margins grant Apple leeway with respect to pricing, but they also place the company at risk of changes in economic circumstances. According to the 2012 Form 10-K, Apple's sales are geographically diversified. The Americas account for 36.7% of net sales, Europe 23.2%, Japan 6.75 and Asia-Pacific 21.2%, the remainder being retail. This geographic diversification helps to mitigate the economic risk that Apple faces. The largest markets in terms of exposure are the United States and the European Union. The economic situation in the United States is moderately favorable at present. The Congressional Budget Office' latest figures show that expectations are for a decline in the U.S. economy in 2013, but these figures price in the effects of the Budget Control Act of 2011, in particular the sequester, and most analysts do not believe that these provisions will go into effect. The CBO projected an increase in the U.S. GDP of 2 1/4% for the second half of 2012, building on an increase of 1 ae % in the first half. The CBO's alternative projections, wherein the sequester would not occur, show a continuation of economic growth roughly in line with recent rates.
The CBO projects that the lack of strong recovery will keep inflation and interest rate suppressed for the foreseeable future. It is projecting an inflation rate of 1.4% for the 2013 fiscal year, below the projected annual average and below the target range set by the Federal Reserve. The market agrees with this assessment. Short-term Treasury paper carries a yield of only 0.1% and ten-year notes are at 1.8% and expected to stay at those levels for the next year. Thus, there is no credible threat of inflation. Corporate profits are currently improving as American businesses gradually emerge from the recession. There has been some recovery in consumer spending, and even signs of life in the housing market (Conerly, 2012), all of which are encouraging signs for economic recovery.
The situation in Europe is more challenging. Both the Eurozone and the United Kingdom are either back into recession or headed in that direct, the result of absurd austerity policies and the effects of the Greek crisis. While the Greek crisis looks to have been averted, this will only turn attention of Euro-skeptics back towards Spain and other nations. Europe has also not yet admitted its austerity policies were a brain-dead failure based on faulty ideology, so it may continue to pursue those policies in the future, further constricting growth. Eurozone growth is expected to improve by 1%, at best, in 2013 (EC, 2012). Japan's economy remains mired -- while the country is wealthy it has little growth prospect. China remains growing quickly, but inflation is still a risk to growth there (Wang, Yao & Koh, 2012).
Apple enjoyed tremendous success over the past four years, despite the economic slowdowns worldwide. The company has enjoyed incredible growth in Asia Pacific and in Japan, but has also grown rapidly in the Americas and Europe. The company's product innovations have driven this growth despite the economic slowdown. These slowdowns often affect consumers outside of Apple's target market (uneducated, rural, older), so the company is less likely to be affected by such slowdowns compared with many other firms. In particular, new product innovations of the past five years like the iPhone (51.4% of sales) and iPad (20.7% of sales) have been key growth drivers. Some older products -- iPods, desktops and software -- have not seen significant sales growth (2012 Annual Report), indicating that product plays more of a role in the company's success than the economy -- without new products Apple might well be affected by shifts in the economy.
Apple's success has been the result of tremendous growth in the industries in which it competes. The iPhone, for example, is Apple's…