Apple's (NASDAQ:AAPL) stock price has been moving up over the last weeks, due to an improving outlook for the second quarter and the rest of the year, as the new iPhone SE seems to be a hit and focus is increasingly shifting away from the iPhone 6s and towards the coming iPhone 7. Apple has stated that the company would announce a new shareholder returns strategy in the near future, and in this article I'll look at a way Apple could act in order to increase shareholder value.
Let's first take a look at Apple's financials:
Apple produced free cash flows of $63 billion over the last year, and has a cash pile of $216 billion on its balance sheet (consisting of $178 billion in long-term investments and $38 billion in short-term investments and cash). Apple has paid out $37 billion to its shareholders in the form of stock buybacks and $12 billion in the form of dividends (for total shareholder returns of $49 billion).
We know that $200 billion of these $216 billion Apple has in cash are located overseas, which means that these cash amounts are not easily available for shareholder returns in the form of dividends or share repurchases (but could be used to make acquisitions, as long as the target is not headquartered in the US).
So far Apple has used another tactic to keep paying large amounts to its shareholders: Apple issues bonds in the US and uses the cash proceeds to pay for dividends and stock buybacks (in addition to the cash flows the company generates in the US). Since Apple has a huge cash position and rather low debt (and interest rates are low in general), the debt Apple issues is cheap and the interest expenses do not really hurt Apple's bottom line (especially since the cash Apple holds offshore also produces interest income).
Apple could, however, also choose to repatriate the cash the company holds offshore, which would mean Apple would have to pay the taxes on said cash, but the company could then use this cash to increase shareholder returns.
Since the corporate tax rate in the US is 40%, Apple would be able to net $120 billion from its $200 billion in offshore cash, which, in combination with the $16 billion in US cash Apple holds on its balance sheet, would equal $136 billion Apple could spend on shareholder returns (or other things), excluding any future cash flows. This means the cash that would be immediately available for shareholder returns is equal to 22% of Apple's market capitalization of $610 billion. Apple hasn't done so in the past, but Apple hasn't had a cash pile this large relative to the company's market capitalization ever: At the end of 2014, Apple's cash position relative to its market capitalization stood at 24%, at the end of 2013 the cash position relative to its market capitalization stood at 29% and at the end of 2012 its cash position relative to the company's market capitalization stood at 24% - right now Apple's cash position relative to its market capitalization stands at 36%, which is the highest level ever by far. I thus believe it is more likely that Apple will utilize its huge cash pile (including repatriating its overseas cash) now, as its cash pile is much bigger now than it ever was before, in relative terms as well as in absolute terms.
Apple returns a lot of cash to its shareholders, mainly in the form of share repurchases, but this approach hasn't been very successful in generating higher share prices, as Apple's share price is down 10% over the last year. I thus believe a different approach could be viable: Increasing the dividend substantially, and at the same time repatriating Apple's offshore cash to keep funding share repurchases for the near future. If Apple repatriated its offshore cash, the company would have $136 billion available right now (as explained above), we can further assume that Apple has at least $50 billion a year available for shareholder returns for the foreseeable future. What could Apple do with this budget?
|Year||Cash position||Cash generation||Cash use||Dividends||Buybacks|
|2016||$130 billion||$50 billion||$76 billion||$22 billion||$54 billion|
|2017||$104 billion||$50 billion||$76 billion||$24 billion||$52 billion|
|2018||$78 billion||$50 billion||$76 billion||$26 billion||$50 billion|
|2019||$52 billion||$50 billion||$76 billion||$28 billion||$48 billion|
|2020||$26 billion||$50 billion||$76 billion||$30 billion||$46 billion|
For Apple's shareholder returns I propose that Apple returns the $130 billion in cash the company would have after repatriating its offshore cash, as well as $50 billion in available cash flow to its owners over the next five years. This means that Apple could return $76 billion to its owners each year. I propose an annual dividend payout of $22 billion (which would equal about $4.00 per share in annual dividends), and that Apple increases the total dividend amount by $2 billion (or about 10%) each year. The rest of the available cash will be used to fund share repurchases. Over the next years the dividend would thus become more important, and the amount of share repurchases would decline relative to the amount spent on dividends.
Apple's investors would not only see their dividends growing by 10% annually though, since the shrinking share count means that per share dividends would grow at a faster pace than total dividends:
|Year||Shares outstanding||Total dividends||Dividend per share|
|2016||5.56 billion||$22 billion||$3.96|
|2017||5.06 billion||$24 billion||$4.74|
|2018||4.63 billion||$26 billion||$5.62|
|2019||4.25 billion||$28 billion||$6.58|
|2020||3.92 billion||$30 billion||$7.65|
|2021||3.62 billion||$30 billion||$8.28|
With the company's share buybacks averaging about $50 billion a year using the model from above, Apple's number of shares declines substantially over that time frame (for the amount of shares retired I used a constant market capitalization of $610 billion, i.e. share price increases are factored in). Through a combination of rising overall dividend payments and a declining number of shares, Apple's dividend would grow by 16% annually over the next years, reaching more than $8 in 2021. This is a very substantial dividend increase over the next years, almost four times the payout we have right now, and yet this should be very financeable for Apple. For the model I assumed $50 billion in available cash flows each year and no growth at all. After the huge cash position is used up, Apple could then choose to keep the dividend payout at $30 billion annually and return the rest of its free cash flows to shareholders via share repurchases (which would mean per share dividends would keep growing).
Why would shareholders benefit from such a move? There are two reasons:
First, Apple would become vastly more attractive for dividend (growth) investors, as the payout for 2016 would almost double and the dividend growth rate over the next years would be a lot higher than it was over the past years as well. This means that those who hold Apple for the income will see far greater results than they expected, and dividend growth investors who didn't hold the company's shares before would likely be interested in buying Apple's shares.
Second, those looking for capital appreciation would be pleased with such a move as well: They get ample share repurchases (at a higher level than in the past years), which means a shifting demand-supply situation and thus higher share prices, and the influx of income investors would result in higher share prices as well. We have seen this effect when Cisco (NASDAQ:CSCO) changed its dividend policy earlier this year (and announced higher share repurchases), boosting its payout by 25% (versus about 10% a year in the past), which resulted in share prices rallying almost 30% from this year's lows.
The surge in demand for Cisco's shares was not surprising (and neither would it be surprising if Apple's share price rallied after a substantial dividend increase), as the market is starving for yield in the current environment. 30-year treasury bonds yield just 2.7% right now, which in many cases is not sufficient to generate the income retirees, pension funds etc. require, thus an increasing number of investors (institutional and retail) are shifting towards dividend growth stocks. We have seen this effect not only in Cisco's shares, which rallied 30% after a new dividend policy was announced, but we see this effect in other income stocks as well:
Over the last year the S&P 500 index is essentially flat (up 0.23%), but consumer companies with strong dividend yields and reliable dividend growth are up a lot over the same time: Coca Cola (NYSE:KO) grew 15%, Altria (NYSE:MO) grew 23%, Philip Morris (NYSE:PM) grew 29%, Microsoft (NASDAQ:MSFT) grew 38% and McDonald's (NYSE:MCD) grew 33%.
The vast outperformance of these stocks versus the broad market can (at least partially) be blamed on the fact that the market is looking for attractive dividend growth/income stocks, which operate in consumer industries and are thus less cyclical than other sectors (e.g. energy). With an increased dividend and faster dividend growth, as well as its strong cash generation and consumer focus, Apple would fit the needs of these income investors and would thus be attractive as well, which means that Apple's shares would likely show substantial gains as well (as a new class of investors enters the stock in an increasing amount).
The proposed shift in capital returns towards higher dividends in addition to utilizing Apple's cash pile would thus mean that income investors as well as those looking for capital appreciation would likely be happy with the results, whereas Apple has been a rather unimpressive investment for both groups over the last year (as the income generated from Apple's shares is low, and additionally investors did not see any capital gains).
Apple could, however, also choose to keep its overseas cash position where it is, and instead increase borrowing up to the point where its overseas cash pile is as big as its debt position. In this case Apple would have about the same amount of cash available for shareholder returns (and could thus follow the plan laid out above), the interest expenses on its debt position would roughly be paid for by the interest income Apple earns with its overseas cash position (i.e. this would not affect Apple's bottom line).
There is also the possibility of a tax holiday in the near future, which would allow Apple to repatriate its foreign cash amounts at a rate far below the one the company would have to pay right now. Republican front runner Trump wants to establish a 10% repatriation tax on offshore cash, and democrats are not avoiding the idea either: Bill Clinton stated he likes the idea of a 10% repatriation tax as well. If there is indeed a tax holiday in the near future, Apple could repatriate its offshore cash at a lower cost, and shareholder returns could turn out to be even higher than projected in the above scenario (which I did with the goal of being conservative).
Apple's cash position hasn't been this large ever before, neither in relative terms nor in absolute terms. Since it does not make a lot of sense to grow the overseas cash position endlessly, I believe Apple could repatriate this cash in order to boost its shareholder returns.
By utilizing its huge overseas cash balance, Apple could prop up shareholder returns substantially over the next years: I believe a combination of a huge dividend increase this year in combination with ongoing dividend growth and share repurchases until Apple's offshore cash balance is used up would be very beneficial for those looking for income from their Apple investments as well as for those seeking capital appreciation.
Past examples (i.e. Cisco earlier this year) have shown that huge dividend increases (even if the company does not have a history of hiking its dividend at a rate that fast) can jump-start a company's share price, and I believe the same could be true for Apple.
Apple could, however, also choose to not grow its dividend very fast this year, but at a fast rate for a couple of years, which would get the dividend to a high level in a couple of years as well (e.g. growing the dividend at 20% annually for five to ten years).
Disclosure: I am/we are 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.