Apple should update its dividend and share buyback plans in April, probably on the same day that it announces its March quarter results. UBS’s Apple analyst, Steve Milunovich, published a note that reinforces what I have written that Apple’s debt load combined with so much of its cash held overseas could limit how much it will increase its dividend and stock buyback. (Note that I have sold my Apple shares and closed my short Call position. This is a trading move so I may get back into the shares.)
I believe the key points to keep in mind besides the debt load and overseas cash is how much profit and cash the company can generate in the US and that Apple will take a multi-year outlook, especially on the dividend and what it essentially obligates the company to pay and grow. Management and the Board know that investors want to not just feel safe about the payout but that the company can continue to increase it every year.
Recent history on Apple’s dividend and stock buyback programs
It was in March 2012 that Apple announced the resumption of its dividend (it paid dividends from 1987 to 1995) and a $10 billion buyback program. It increased the dividend by 15.1% and the buyback program to $60 billion in April 2013 and in April 2014 the dividend grew by 7.9% and the buybacks went to $90 billion in total to be completed by December 2015. As of the end of 2014 Apple had paid out $27 billion in dividends and bought back $73 billion in shares.
To help fund the buyback programs Apple has taken on about $39 billion in debt since May 2013. It started with a $17 billion debt offering then added $12 billion in April 2014 followed by 2.8 billon Euros (about $3.5 billion) in November 2014 and $6.5 billion in February this year. While there are press reports that Apple raised 1.25 billion Swiss Francs (about $1.35 billion) I have not found any SEC filings about this. Depending on how concerned management and the Board are about its debt ratings there could be a limit to how much debt the company is willing to take on. I estimated that it should take at least $25 billion in additional buybacks to move the EPS needle enough to get investors interested.
I believe Apple will increase its dividend somewhere between 6% to 9%. The main reason that it won’t be higher (besides that last year it went up 8%) is the compounding impact of doing this over a five to ten year timeframe. A key limiting factor is only being able to pay dividends from US cash flow, additional debt or bringing back overseas cash and paying additional taxes on it, which I don’t believe Apple would want to do. While the actual amount of cash spent on dividends is lessened by buying back shares once a company gets on the raise its dividend every year treadmill it has to be cognizant of any impacts to its business if it starts to run short of US cash.
When Apple started its dividend and buyback program at the end of fiscal 2012 it had $38.7 billion or 32% of its $121 billion in total cash in the US. At the end of December 2014 this had fallen to $20 billion of its $178 billion (which was augmented by $36.4 billion in debt) or 11% of the total.
Milunovich believes that Apple may wait for clarity on a tax holiday
Milunovich brings up a good point that with the recent chatter out of Washington about lower tax rates on overseas profits that Apple’s management and Board may decide to announce a smaller buyback with a shorter timeframe than what it has done in previous announcements. This could very well be a prudent move by management but there seems to be a number of investors and analysts that are calling for a large increase to the share buyback program so they could be disappointed.
Milunovich calculates that Apple could generate US cash of about $25 billion over three years after dividend payments and acquisitions. His analysis also assumes that Apple will want to keep its very good debt ratings by keeping its debt to EBITDA ratio at 1x or less. This would lead to total buybacks of $50 to $70 billion over three years. If Apple is not as concerned about its debt ratings then it could increase this buyback amount. To get to a $1 trillion market cap I believe it will need to be aggressive with its share buybacks as it could be tough for Apple's share to reach a market PE multiple.
R&D and acquisitions shouldn’t be impacted by a reasonable capital return increase
I believe that Apple is not hamstringing its Research and Development efforts (R&D) by implementing such a large stock buyback program. It has more than doubled its spending over three years from $2.4 billion in fiscal 2011 to $6 billion in fiscal 2014. While its spending as a percent of revenue at 3.3% last year is much lower than other technology companies I attribute that to it having a much smaller product portfolio and generating so much revenue. Its strategy of focusing on a limited set of solutions has served it well and increasing its R&D spending faster than it already is could create more issues than great products.
I believe Apple has also been smart in its acquisition strategy of buying small companies with technology that Apple can leverage. The company has been diligent about its acquisitions and except for the Beats buy they have had almost no impact on its cash balance (and Beats may have been done with overseas cash). One reason I believe Apple has shied away from large mergers is that it would probably be difficult for a company with such a strong culture to integrate a large company. Overall I also believe that tech mergers have done more financial harm than good and that Apple should return its excess cash vs. trying to buy its way into another segment. It can even cover the expense of researching the car market even though I don’t believe it will wind up designing and manufacturing a complete car.
Apple has generated very good returns on its share buybacks
Milunovich estimates that Apple has generated a return of 57% over the ten quarters it has been buying back its shares or 23% annualized. It would be very difficult to find another investment or company that could generate these returns.
Milunovich does point out that Apple’s PE multiple has increased 50% from its mid-2013 low of about 10x to about 15x at the end of December 2014 and has further increased to 17.5x on trailing earnings. The higher valuation and subsequent lower returns on buying shares may get Apple to temper how much it decides it wants to buy in the upcoming announcement.
Shares are in overbought territory but this could be short-lived
Apple’s shares have taken a breather the past two days as it has fallen from about $133 to just under $129 (Milunovich’s note also came out two days ago). The drop isn’t a surprise since it had been up 9 of the previous 10 days and been strong since it announced December quarter results. Both its Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) are in overbought territory but have decreased the past two days with the stock’s decline.
