- Apple spent almost 80% of its U.S. generated cash in fiscal 2013 on dividends.
- The company will be limited in how much it can raise its dividend.
- A smaller than expected dividend increase may disappoint investors.
- Taking on debt to fund dividend payments is not a sound business decision.
Tim Cook, Apple's CEO, said that the company would update its capital return plan by the end of April. So it makes sense that the announcement should be in tandem with its earnings release after the close on Wednesday, as the company did in 2013. Apple (NASDAQ:AAPL) had $158.8 billion in cash and investments as of December 28, but it "only" had $34.4 billion in the U.S., or 22% of the total. It used almost 80% of the cash it generated during the year to pay its dividend, which is now $12.20 per share.
Apple did buy back $14 billion, or about 28 million of its shares in the late January/early February timeframe, which will save almost $350 million in yearly payments. However, that is only 3.3% of its total dividend payments. While additional buybacks will help lessen the cash needed for dividends, I believe the company will have a difficult time raising its dividend by much more than 5%.
I also believe that management and the Board are taking a multi-year view of its dividend policy. They probably did and continue to review how much U.S. cash can be generated and balance it against share buybacks, acquisitions and downside business scenarios. All of these factors should limit a dividend increase to 5% and 10% at best. Of course, everyone would probably like to see it increase on a yearly basis, but any dividend commitment at a higher level only increases the pressure on U.S. cash over a multi-year timeframe.
Payout ratios are almost meaningless
Yes, Apple generated $50.9 billion and $53.7 billion in operating cash flow the past two fiscal years. After capital expenditures, free cash flow was $43.5 billion and $45.5 billion, respectively.
Some people will look at these numbers and say that the payout ratio was only 23% in fiscal 2013 ($10.6 billion in dividends divided by $45.5 billion in free cash flow). I believe that is a flawed analysis since so much of the cash generated each year is overseas and can't be used for dividends. This ratio was a good one to use when companies generated much more of their earnings in the U.S., but with overseas sales generating a significant amount of profit, it loses almost all of its value.
Apple generated about $13.9 billion and $13.3 billion in U.S. cash in fiscal 2012 and 2013, respectively. For 2013, its payout ratio was 79% of the U.S. cash it generated, which is very high.
Another headwind to increasing the dividend by a significant amount is capital expenditures are expected to increase by almost $3 billion in fiscal 2014 to $11 billion. Since I suspect a large amount of the increase is to build its new corporate headquarters in the U.S., this could put a further damper on increasing the dividend or share buyback.
The remaining U.S. cash hoard is to run the business and buyback stock
After Apple bought back the $14 billion on shares earlier this year, the company's U.S. cash dropped to $20 billion plus what it generated in the March quarter. Since Apple does need some level of cash to run the company and have funds to make acquisitions, there may not be a lot left over to buy back stock or raise the dividend without taking on debt.
The company does have about $17 billion in debt, and Moody's published a report last year that Apple could take on an additional $20 to $25 billion in debt before it affected its credit rating. Overall, it's not a good idea to take on debt to increase a dividend (but it can work to buyback shares). That is because Apple may have to take on more debt each year to pay its dividend if U.S. generated cash doesn't increase or if there isn't a tax holiday to bring back overseas cash.
Congress passing a tax holiday would be huge
In 2004, Congress enacted a tax holiday that allowed corporations to bring back foreign profits at a 5.25% rate. There was $362 billion brought back with a large amount going to dividends, stock buybacks and acquisitions. Since only a small amount was probably used to create jobs, Congress has not been able to pass another holiday.
If one were to pass, I believe Apple and other companies would bring even more expatriated cash back as long as there weren't tight restrictions on how it could be used (and it is probably very difficult to track it). This would be a significant positive for the stock.
Additional disclosure: 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.