Watching how the market values growth companies is always interesting to observe. Today, few growth stocks get as much attention as Apple (AAPL). While longs and shorts seem to agree that Apple's future growth rate is likely to slow at least moderately in the coming years, Apple's ability to generate free cash flow continues to accelerate.
While the market traditionally values growth stocks based on what traders and investors believe is likely to be a company's average growth rate for the next several years, Apple's unique ability to generate massive cash flow in the U.S. and abroad makes valuing the company even more difficult.
Today, Apple shares are now trading at around $560 dollars a share, and the company's market capitalization is around $525 billion dollars. Still, while Apple may have years of strong growth ahead, Apple traders and investors are still giving this company, that has grown its net income at over 75% the last three years, a forward price to earnings ratio of just around 11x average estimates for next year's likely earnings. Today, Apple is trading at a below average multiple even though the company's shares have consistently outperformed the S&P 500 and its tracking exchange traded fund, SPY, as well as most of the other broader indexes, by a significant margin.
With Apple's valuation suggesting the company's growth will likely slow significantly in the coming years, it is interesting to see how the company's ability to generate free cash flow in the coming years may affect the company's valuation.
While Apple had around $100 billion on the company's balance sheet in early April, only one third of the company's cash is in the United States. Apple also pays an international tax of less than 5%, compared to the 35% corporate tax the company pays in the United States. Apple generates around one-third of its revenues from the United States.
Most analysts are projecting Apple will generate around $30-35 billion a year in free cash flow over the next five years, with around 30% of the company's revenue in the United States. This analysis suggests that Apple will have around $185 on the company's balance sheet by 2015, and nearly one-third of that will be in the United States.
The problem is that Apple currently pays an average tax of less than 5% on international income, while the company pays a 35% tax on U.S. revenues, so repatriating cash would be costly. Also, obviously, the company's best growth markets today are in countries such as China where Apple's revenues doubled over the last year, so Apple will likely continue to invest more abroad over the coming years.
Still, with Apple's current payout ratio around 20%, far less than the S&P 500 average of 40%, if Apple were to raise its payout ratio to 25-30% over the next five years, the company would still likely be able to considerably raise its $9 billion dividend. Since Apple will likely generate $30-35 billion a year in free cash flow over the next five years, the company still has significant cash on its balance sheet in the U.S. today, and one third of the company's revenues will likely be in the United States.
If Apple is generating $30-35 billion a year in free cash flow over the next five years, and the company maintains its current policy of paying out around 30% of free cash flow generated in the U.S., Apple should have an additional $1-2 billion in free cash flow that management will likely look to return to shareholders through buybacks or dividends. If Apple was able to increase the company's dividend by around $1-2 billion a year, the company's dividend would obviously double in around five years.
Still, other options remain.
Apple could still issue short-term corporate bonds at 1-2%. Microsoft (MSFT), also a company with significant cash on its balance sheet and no previous debt, issued corporate bonds at nearly 1% above the yield on the 5 year U.S. treasury bond several years ago. Today, the 5 U.S. treasury bond is yielding around .66%, and the 10 year U.S. treasury bond is yielding less than 1.5%. With fear levels high and demand for high quality bonds strong, Apple could likely issue billions in 5 year bonds at less than 2% since the company would obviously have its bonds rated triple A.
Also, while Congress will likely remain divided between the parties, corporate tax reform may be an issue Republicans and Democrats can work together on, and a tax holiday for companies repatriating cash to the U.S. will likely be one possible idea that will be discussed. Democrats would likely insist that at least some of the money repatriated to the U.S. at lower tax rates would be used for job creation. Still, if Apple were to be able to repatriate even 30% of its nearly $75 billion dollars in overseas cash, the company could likely pay out an additional $6-7 billion a year in dividends since Apple is likely to generate around $20 billion a year in free cash flow over outside of the United States over the next five years.
Apple would also likely use a significant portion of the company's nearly $75 billion in overseas cash on its books to increase dividend payments as well. If Apple was able to use a third of its overseas cash to pay out dividends, and the company was also able to use a third of its future free cash flow abroad to pay out dividends, the company could easily double its dividend today.
To conclude, with Apple's growth rate likely to slow at least moderately in the coming years, the company's ability to return cash to shareholders will likely become increasingly important. While Apple should be able to grow its dividend significantly over the next five years, a change in U.S. tax law could provide a huge incentive for Apple to increase the company's dividend and buyback program much more aggressively.
Today, Apple's best growth opportunities are abroad, with the company still generating less than 20% of its total revenues from China, despite doubling its revenues from the world's second biggest economy in the last year. Still, with Apple employees also able to accrue dividend payments on back dated call options with the company's recent amended filing, the company continuing to generate significant free cash flow, and management more focused on returning cash to shareholders, Apple will likely continue to look to increase the company's dividend payouts in the coming years.