Our take on the US tariff war is that uncertainty reigns today, which will probably result in forecast cuts for many of the companies we research. The longer the trade war continues, the more forecasts will be cut until we reach a steady state. We will have to respond with market-level forecast cuts if tariffs remain for much longer.
The Golden Screw. During the COVID era, many Western manufacturers moved manufacturing outside China to countries like Vietnam and Mexico. However, there are still components that are made mostly, or exclusively, in China; we saw this happen during the COVID-era, and we were told at the time these are the “golden screws.” Golden screws are understood to be potentially low-value parts that are necessary, and even though they cost 2 cents (yes, going to 4 cents), they may as well be made from gold (maybe for $20) because they are not available for purchase. In their absence, a final product cannot be manufactured until the device is redesigned.
Full Capacity? Additionally, as noted, many IT equipment companies have updated relationships with their manufacturing partners to ensure they have manufacturing capacity in countries such as Vietnam. However, not all manufacturers have moved away from China, which is tricky. Let’s assume that Western vendors can no longer access Chinese manufacturing or access it affordably. Then, all manufacturers will clamor after non-China manufacturing lines, causing a run on that capacity akin to a run on the bank. We expect that allocation behavior, evident during the COVID era, will repeat itself. In other words, when non-China manufacturing goes on “allocation,” we’ll see that production runs go on allocation even for IT equipment companies that took the time to move manufacturing outside of China. Additionally, just like we saw during COVID, IT equipment companies who get put on manufacturing “allocation” first are those who make lower-margin products or who represent smaller revenues to the manufacturers, putting a priority on higher-margin products and OEMs who are very large (and/or growing). Once manufacturing “allocation” happens, we could see price escalation; to wit, during 2022 and 2023, we saw enterprise WLAN Access Point shipments fall only ~5% short of our pre-pandemic unit forecasts, but selling prices soared to the vicinity of +40-50% versus pre-pandemic pricing.
Forecasting. Regarding our forecasting, we think the longer the tariffs remain, the higher the uncertainty and, thus, the higher the likelihood of forecast cuts. Given that some tariffs got forestalled yesterday, they all may get delayed or forestalled. However, if tariffs aren’t gone, market-level forecasts must come down at some point, maybe in weeks or months. And think about it, we will see this during the earnings calls cycle that is just beginning. What is the incentive for IT companies to raise or even maintain guidance? Not much, and more likely, it is a good practice to cut guidance when uncertainty reigns.