Apple (NASDAQ:AAPL) has now paid the same quarterly dividend of $3.05 per share for 4 consecutive quarters. That brings up only one question in the minds of dividend growth investors. Is a dividend increase on its way? The answer is an emphatic "yes" based on the factors discussed below. The article also lists a few points why Apple might in fact "need" the dividend increase. Let us get into the details.
Why this discussion now? As mentioned above, the same dividend has been paid for 4 quarters. And it was in April last year that the company announced its first dividend increase since the dividend reinstatement in 2012.
Affordability and Comparison: Let us start with the obvious reasons why a dividend increase is almost guaranteed. Apple can afford it. And equally important, Apple needs it. Take a look at the table below. Apple has the 2nd lowest yield and the 2nd lowest payout ratio among the 5 companies profiled below. Most investors will agree that Apple's days of super growth are behind it and that it, like the rest of the companies shown below, must attempt to please investors through dividends and buybacks as well. This is not to say there will be no growth but the point should be clear.
That brings us to the one company that has a lower yield and lower payout than Apple, International Business Machines Corporation (NYSE:IBM). How does IBM have such a low payout ratio and yield in spite of paying increasing dividends for 18 consecutive years? The answer is simple: consistent dividend increases and share buybacks when combined with even flat earnings, propel the share price forward.
(Source: Data from Yahoo Finance)
Amazing Free Cash Flow: The chart below shows Apple's quarterly free cash flow for the last 5 years. The red circles show the minimum, average, and maximum cash flows.
- The average quarterly free cash stands at almost $8 billion.
- Total share count is at 890 million as of this writing.
- The current quarterly dividend payment of $3.05 means the company requires $2.7 billion (890 million times $3.05) to cover quarterly dividend payments. Let's say Apple announces a 15% increase. The new quarterly dividend will be $3.50 per share. That would push the quarterly dividend commitment to $3.1 billion, which again is handily covered by the free cash flow.
- The highest free cash flow was $21 billion during the record fiscal Q1 of 2013.
- The lowest quarterly free cash flow was $725 million back in 2009. It is safe to assume the free cash flow will not fall to this level at least in the immediate future. That would represent a 96% reduction in free cash flow compared to the most recent quarter.
- All those numbers put together tell us that Apple's dividend is extremely well covered from the free cash flow perspective.
Share Count: Talking about buybacks, here is a look at Apple's outstanding shares. Since October 2012, when the share count hit a maximum of 940 million, Apple's buyback program has reduced the shares outstanding by 5%. This is not bad considering the fact that the company has been buying back shares for less than two full years now. As a comparison, Microsoft Corporation's (NASDAQ:MSFT) share count has gone down only 6% in the last 5 years.
Needless to say, buybacks a) reduce the float, b) increase earnings per share and c) reduce the total dividend amount paid to shareholders as more shares are retired.
Cash Strength: As old as it sounds, it is hard to talk about Apple but not bring the cash pile into the picture. Whether you believe holding 10% of corporate America's cash is way too much or that the company actually needs more domestic cash, the $160 billion cash pile is rock solid and is climbing each quarter. Even taking the potential repatriation taxes into account, that's a position most companies could only dream of.
- Apple is still expected to grow its earnings at 21%/yr for the next 5 years. As great as that sounds, it's a far cry from the scorching 50% growth the company saw in the previous 5 years. With uncertainties about the next great product, 21% seems too optimistic right now. But it is not beyond Apple's reach to produce double-digit earnings growth through organic means as well as buybacks.
- That said, the estimates for the next few quarters and years have remained fairly steady as shown below.
(Source: Yahoo Finance)
Extrapolation: Yes, Apple does operate in a disruptive environment. And yes, earnings are under pressure. But based on the room available in EPS, FCF, and cash, it is not totally unreasonable to expect 15% dividend growth for the next 5 years. The yield on cost for investors buying here will more than double in 5 years.
- Even if we assume earnings stay flat at $40 per share (ignoring the estimates above), the potential 2019 dividend represents a very manageable payout ratio of 60%.
- For the payout ratio to go above 100%, earnings per share will have to fall 10% per year from 2014 to 2019.
(Source: Current dividend and share price data from Yahoo Finance)
Increase in Floor Price: Will a new dividend increase the floor price for the stock ? Likely. But not bullet-proof. There are quite a few stocks that have a well-defined dividend yield level (which means floor price for the stock) like Johnson & Johnson (NYSE:JNJ) and Coca-Cola (NYSE:KO) at 3%. Obviously, Apple is not in that league when it comes to dividends and also operates in a much more disruptive industry. But:
- A higher dividend will likely discourage more short-sellers (as they have to pay the dividends when shorting)
- A higher dividend will likely blend well with the buybacks to set up a higher floor, as discussed here.
- Apple's recent bottom came around the 3% yield point. If the new dividend comes in at $14 per share, the 3% yield mark will be around $465.
Conclusion: So, all these points put together should convince everyone that a dividend increase is well on its way. In addition, Apple is in a good enough position to stitch together a nice dividend growth streak. For the record, we believe the new dividend will be between $13.50/yr and $14/yr, an increase of 10% to 15%. Knowing Apple's conservative nature it's hard to imagine them overstretching and anything less than a 10% increase will likely result in a disappointing sell off. With not too many reliable stocks to choose from technology when it comes to dividend growth, Apple is certainly in a good position to go up the ranks.
Disclosure: I am long KO. 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.