If the stock market were a social endeavor, Apple (NASDAQ: AAPL ) would be the nouveau riche, or new money. While the company has $137 billion in the bank, this sum has been built up in a staggeringly fast time. In the past year alone, Apple has generated more than $47 billion in free cash flow.
In an article comparing Apple with ExxonMobil, its big-oil nemesis for the crown of the world's most valuable company, I noted how Exxon is in a different category than Apple, having returned a staggering $265 billion to shareholders over the past decade. More than $75 billion of that amount was in dividends alone. Exxon's the old money, having existed in one form or another since 1882 and having a history of 30 straight years of dividend raises.
Yet with a very slight decline in earnings per share last quarter and a forecast for a larger fall-off in earnings next quarter, Apple is finding investors clamoring for it to accept its new reality of lower growth and act like its old-money peers. So let's look at Apple's recent history at giving capital back to its shareholders, and what it can do with its $137 billion across the next year.
How will Apple use its cash?
Simply put, as companies generate operating cash flow, they have five main options for how to use it.
- Spend it on capital expenditures.
- Use it for acquisitions.
- Return the money to shareholders as a dividend.
- Buy back their own shares.
- Hoard it.
Currently, Apple has been following the final option and has accumulated $137 billion that's managed by its Braeburn investment unit. How might the company attack the other four ways it can use its operating cash flow in the future?
It might shock some investors, but the company's biggest use of its operating cash is actually capital expenditures. Apple spent $9.3 billion in the past 12 months on capex and expects to see that total continue to rise across the coming year. The reason is simple: While Apple uses outsourced manufacturers such as Foxconn to build its devices, it's increasingly had to buy its own equipment for those factories to secure supply-chain stability.
Next, we look at acquisitions. There's no way around it: Most acquisitions fail. Luckily for Apple shareholders, the company isn't very acquisitive. Sure, it'll make smaller bets on interesting technologies, such as when it bought Siri or recently swallowed up fingerprint-recognition company AuthenTec, but these are smaller deals. To this day, Apple's largest acquisition in history is still believed to be its 1997 purchase of NeXT for $404 million.
Point being, as a shareholder, there's little fear that Apple will waste its money on something like Microsoft
's (NASDAQ: MSFT
) later abandoned $45 billion buyout offer for Yahoo!
or its later completed $8.6 billion deal for Skype. Today, even after a recent rally, Yahoo! trades for $24 billion, which helps illustrate the dubiousness of the deal.
That leaves us to examine dividends and share repurchases.
How Apple's dividends stack up
Apple first announced its dividend on March 19 of last year. The company announced a dividend of $2.65 per quarter, with those dividends beginning in Apple's September quarter. Along with its dividends, Apple announced a $10 billion share-repurchase program that started last quarter. With these two programs combined, Apple anticipated returning $45 billion to shareholders across three years' time.
At the time of Apple's dividend announcement, it was a solid step in the right direction, but nothing groundbreaking. Apple's dividend of $10.60 per year was about a 1.8% yield of its then-share price of $595 per share. As Apple's share price has dropped, its yield has risen, though it still trails many big-tech peers.
||Dividend Yield (%)
||Payout Ratio (%)
||Annual Dividend Payout
|Intel (NASDAQ: INTC )
|Google (NASDAQ: GOOG )
Source: S&P CapitalIQ. Payout ratio is trailing net income divided by annual dividend rate.
*Microsoft took a $6 billion impairment of goodwill in the past year. Without that impairment, its payout ratio would be closer to 35%
Apple's absolute amount of dividend payments trumps its big tech peers aside from Google, a company that has yet to institute a dividend of any kind. Because of Apple's significantly larger market cap than other tech companies, its dividend yield is much smaller. With only a 24% payout ratio, there's plenty of room left for the company to increase its payouts.
Are share repurchases the way to go?
Other than dividends, the other part of Apple's announced $45 billion plan to return capital to shareholders was a $10 billion share-repurchase program. If used correctly, share repurchases can be an effective tool.
The problem with Apple's repurchase program is that it simply isn't significant enough. If averaged over three years, the repurchase program buys back $3.3 billion per year. That's about 7.5 million out of Apple's existing 939.1 million shares outstanding.
However, Apple awarded $1.7 billion in stock-based compensation last fiscal year. That number surged from the $879 million Apple awarded in fiscal 2010. Apple still pays much less in stock-based compensation than a competitor such as Microsoft or Google. (Google has recorded $2.7 billion worth of stock-based compensation in the past year.)
Apple itself noted this situation in commencing its repurchase plan, noting its "primary objective of neutralizing the impact of dilution from future employee equity grants and employee stock purchase programs."
More repurchases on the way
The problem with Apple's announcement of its dividend and repurchase program was that the company set the timeframe over too long a period. If Apple held free cash flow around $50 billion over the coming three years and paid out its full announced $45 billion in dividends and share repurchases, it'd have more than $250 billion in the bank.
Apple surely realizes this coming "problem," however, and I think an astute investor would realize the company is already taking steps in the direction of upping its share-repurchase commitments, even if CFO Peter Oppenheimer has maintained that the company is comfortable with its current $45 billion commitment for the time being.
- Last quarter, the first quarter of Apple's $10 billion repurchase program, the company spent $1.95 billion in repurchases. That's already 20% of the purchase commitment in a single quarter. Front-loading repurchases in this fashion seems to indicate that the company will quickly blow through its $10 billion in repurchase commitments.
- In giving guidance for the coming quarter, Apple used almost every metric necessary to come up with its earnings per share (EPS) -- revenues, gross margins, operating expenses, the amount of interest its cash will collect, and a tax rate. Yet despite this trail of bread crumbs leading to its EPS, Apple didn't give an EPS. The only major area needed to calculate EPS that Apple didn't give is its share count. Simply put, Apple seems undecided on how many shares it'll purchase in the upcoming quarter.
If Apple was undecided on how to use its repurchase program, the 14% selloff post-earnings gives it a perfect window of opportunity. While Apple has never exactly been nimble when it comes to its cash management, it now has an opportunity to rebuy its own shares at less than 10 times earnings.
Consider that Microsoft has been aggressively repurchasing its stock across the past decade, with little to show for it. However, it predominantly did so when the company wasn't cheap. Microsoft purchased an astounding $27.6 billion of its stock in fiscal 2007, a year when its average P/E was between 22 and 23 times earnings. The surest way to burn a cash hoard is to buy back a company's overpriced stock.
If Apple were to accelerate its share-repurchase program, it'd avoid the trap of past companies. It wouldn't start aggressively buying when the company was at 20 times earnings or more; it'd be when Apple was at a P/E of around 10 or less.
No discussion of Apple's cash hoard would be complete without noting that $94 billion of its cash is held overseas and subject to additional repatriation taxes if the company wants to get more aggressive about returning capital. Yet with Apple still getting about 40% of its sales from the United States, that could leave about $20 billion a year in cash flow from America alone. Given that Apple currently spends only about $13 billion a year between dividends and share repurchases, the path forward looks clear.
It's time for Apple to get off its wallet and start being more strategic repurchasing its shares. Let's hope the initial signs from the company lead to the right decision: increasing its share repurchase allocation and getting more strategic with its cash.
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