As most Apple (NASDAQ:AAPL) investors know Tim Cook, Apple's CEO, said in a Wall Street Journal interview last week that the company had bought back $14 billion worth of its shares in the ten days since it reported its results on January 27. While I believe this is a good move on the management's part I also believe that the decreased amount of U.S. cash, management's willingness to be aggressive in buying back shares when they view them as undervalued and the company's challenge to increase the amount of U.S. generated cash will limit its ability to increase the dividend by a meaningful amount.
Apple generated about $13.3 billion in U.S cash in fiscal 2013 and paid out $10.6 billion in dividends for the year. It also bought back $22.9 billion in stock, which was largely funded by the $17 billion in debt it took on along with decreasing its U.S. cash by $3.2 billion to $35.5 billion. One of the key challenges for Apple to increase its dividend by a larger percentage than 10% is that it has to be funded by U.S. cash.
I expect the dividend to increase by 5% to 10% on a yearly basis
When management and the Board analyzed the dividend payment I believe they took a multi-year if not a multi-decade outlook. One key item they would be thinking about would be raising the dividend on an annual basis. Many funds and investors are looking not just for a nice dividend yield but the prospect that it will be raised on an yearly basis. While Apple has only been paying one since August 2012 not just maintaining the dividend but raising it 5% to 10% per year would make the shares more "valuable" to dividend oriented investors.
This means that for the company to increase it by 10% each year it will have to pay out an additional $1 billion more in fiscal 2014. Then if it wants to increase it by another 10% it will have grown by about $2 billion in fiscal 2015 and then in the third year (we'll you get the picture). While the company should be able to grow U.S. generated cash it probably won't be able to over a five to ten year timeframe at the same pace outlined above to fund the dividend and maintain an meaningful buyback program.
Therefore, I expect the company to announce it will raise the current quarterly payment from $3.05 to between $3.20 to $3.35 or a 5% to 10% increase.
Buybacks help but aren't enough
While the share count could decrease at around 5% per year for a year or two I don't believe it can be sustained at that level unless management decides to bring back overseas cash and pay a large tax (something I would prefer that they don't do) or take on a significant amount of debt (which would only make sense to me if the shares dropped back to around $400 and even then it may not take on enough debt to decrease the shares by over 10% or $45 billion). I don't think it is a good idea to saddle the company with too much debt if it could limit its options down the road. At some time there should be a change to the tax code that would then make sense to bring back overseas cash and then it could throw a large amount at buying the shares.
There are probably limits to how much debt the company is willing to take on
Moody's also weighed in on how much debt it believes Apple could take on and not risk a credit downgrade. On December 5 last year Moody's published a report that Apple could take on an additional $20 to $25 billion before it may affect its credit rating. This is about how much the company could need to fund its current buyback program unless it dips into its U.S. based cash ($34 billion). I believe it makes sense to use $10 billion if not $20 billion but not more than that (which it had to do to fund the recent $14 billion it spent). While a credit downgrade is not the end of the world since the financial result is a slightly higher interest rate it would probably at least make management and the Board hesitant and overall limit what the company would do.
Apple didn't have too much excess cash five years ago
Keep in mind that at the end of fiscal 2008 Apple had "only" $24.5 billion in total cash and investments and of that $13.2 billion or 54% was in the U.S. Total cash and investments doubled to $51 billion by fiscal 2010 with $20.2 billion in the U.S. or 40% of the total. Over the past three years Apple's cash hoard has exploded so it makes sense that the company took its time to establish a dividend and buyback program and now at $100 billion does plan to return to shareholders a significant amount of it.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Sand Hill Insights and Chuck Jones is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Sand Hill Insights/Chuck Jones does not purport to tell or suggest which investment securities readers should buy or sell. Readers should conduct their own research and due diligence and obtain professional advice before making investment decision. Sand Hill Insights/Chuck Jones will not be liable for any loss or damage caused by information obtained in our materials. Readers are solely responsible for their own investment decisions.