What Does Brexit Mean For Apple's Dividend Investors?

| About: Apple Inc. (AAPL)

Summary

Brexit is unlikely to impact Apple’s ability to pay a dividend.

Third-quarter earnings are expected to miss.

Investors who play the market volatility over the next month correctly stand to benefit from a higher dividend yield and preferential positioning ahead of a new iPhone release.

Analysis

Brexit and the next iPhone. As Apple's (NASDAQ:AAPL) third-quarter earnings results loom, the fallout from its tepid second quarter has cast a pall over the stock. To recap, Apple reported fiscal 2016 second-quarter revenues that were 13% lower than they were in the prior year, resulting in a rare earnings miss by the technology behemoth.

Ostensibly, Apple's second-quarter performance was the end-result of flattening demand for smartphones (the iPhone accounts for around two-thirds of its revenues) as manufacturers slowed the pace of innovation and instead focused on incremental improvements to their products and accompanying services. Attention has now shifted to the launch of the next generation iPhone and whether it can turn around the fortunes at Cupertino.

Meanwhile, the impact of Brexit has only begun to ripple through markets. Apple, which generates close to 24% of its revenues from Europe, could see some headwinds as economic dislocations impact consumers' willingness to spend on its latest and greatest products.

The negative confluence of a lukewarm outlook for the company and macroeconomic concerns have hurt Apple's share price: the stock is down by 11.6% in the year-to-date. This far outstrips the 1.6% decline in the Dow Jones Industrial Average, of which Apple is a component, during the same period.

Dividend Impact and Outlook. For investors, the silver lining to Apple's recent run of ill fortune is that its dividend yield is at its highest level in four years. The stock now yields over 2.4%, which means that investors who buy Apple shares can expect passive income of at least $240 a year.

Apple has a fairly consistent track record of paying dividends, having done so on a quarterly basis since August 2012. During this period, Apple has raised its dividend four times or roughly once every year. Despite its subdued second-quarter results, Apple raised its dividend from 52 to 57 cents per share.

We believe that there's no doubt that Apple will continue paying - and possibly raising - its dividend for the foreseeable future. Here's why:

First, Apple has enough cash to make Midas envious. On the face of it, Apple has just $1.28 of working capital for each dollar of short-term liabilities. However, this doesn't include Apple's massive holdings of US Treasury and Corporate securities, which are recognized as "long-term" assets. For tax purposes, Apple prefers to hold these assets overseas and instead funds its general corporate activities - including its dividend payments and stock buybacks - by issuing debt. Nonetheless, it is this enormous "strategic reserve" that permits Apple to be active in the capital markets in the first place - banks and other lenders would be less likely to provide Apple with funding if it didn't have such a large pool of untapped liquidity elsewhere. If we were to add Apple's overseas trove to its working capital, the working capital ratio that emerges is nearly 3.9-to-1.0 - or nearly double the level of its peer group.

Second, Apple's level of debt is fairly low relative to its capital. Despite issuing bonds on a fairly regular basis over the past few years, Apple has only 60 cents of long-term debt for every dollar of equity, which is fairly consistent with the average for its industry. This means that interest and related payments are unlikely to impede the payment of dividends. Indeed, during its fiscal second quarter, the interest and dividend income that Apple earned from its hoard of marketable securities ($986 million) was more than triple the amount of interest that it paid on all of its debt ($321 million) during the same period.

Of course, this is where the impact of Brexit comes in - over 63% of Apple's war chest is held in the form of corporate securities and mortgage-backed securities, which are not as "safe" as US Treasuries (which, in turn, have benefited from Brexit). A 10% decline in the value of these securities would hit Apple with a nearly $15 billion paper loss - but as long-term assets, Apple doesn't have to sell these securities. With its access to capital markets and its large available cash holdings, Apple has the ability to ride out an economic disruption until market prices stabilize.

Third, while Apple's revenues have dipped recently, these are likely to pick up with the introduction of new iPhone models - indeed, if one goes over Apple's earnings history, one will observe that the introduction of new iPhone models has consistently resulted in record revenues and earnings results.

While it's certainly fair to argue that this time could be different, the central expectation is that Apple's revenues will rise by over 9% each year over the next half decade. To be sure, this is lower than the growth predicted for its sector - but it is still better than the growth rate anticipated for the S&P 500.

More importantly, Apple's operating income margin is still at a very robust 27% - superior to the 3% margin of its peers. To the extent that Apple is able to defend or expand this margin, it will be able to add cash to its already considerable pile and will likely seek to return some of it to shareholders in the form of further stock buybacks and dividends.

Could Brexit mute the sales impact on a new iPhone? As we mentioned, Europe accounts for over a fifth of Apple's sales so any disruption to this region is worrisome. That said, it's worthwhile to note that European demand still managed to grow during the last comparable period, which was during the Grexit crisis in the second and third quarters of 2015 (corresponding to Apple's Fiscal 2015 3rd and 4th quarters).

More likely, Brexit's impact on Apple's operating results will be in the form of a stronger US Dollar that eats into its currency-translated sales. Nonetheless, this should have little bearing on Apple's ability to pay its dividend - during the second quarter, the impact of currency translation on revenue growth was approximately 4% while the impact on its cash was minimal.

Conclusion

With Apple likely to continue paying dividends for the foreseeable future, the best strategy for investors is to wait for Brexit-induced market volatility to subside before buying Apple shares. This entails waiting out the next month at least, which is prudent considering that Apple is slated to release its fiscal third-quarter earnings in the next 30 days. These results are likely to see Apple report a 15% decline in revenues, further weakening the stock.

Following this strategy will enable investors to maximize their dividend yield and position themselves in the stock ahead of the release of the new iPhone.

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.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.