Will Apple Increase Its Dividend Tomorrow?

Apple's (NASDAQ: AAPL  ) dividend will undoubtedly be a hot topic at the company's annual shareholders' meeting on Wednesday. Though Apple's prospects as a growth stock are under the microscope, there is no question that company is a cash cow. In fact, a close look at hedge fund manager David Einhorn's controversial debacle with Apple over the last 30 days highlights that Apple's quite capable of increasing its payout.

Apple is a cash cow 
Though Einhorn is taking Apple to court over its "Depression-era mentality" regarding its cash hoard, there is no denying that he is a big believer in Apple's future. His hedge fund, Greenlight Capital, recently disclosed that it increased its holdings in Apple by 20% since the end of the year. Apple was already the fund's largest holding.

Now, together with $146 million in Apple call options, Greenlight Capital's position in Apple amounts to $746 million. This means Apple makes up about 11% of the hedge fund's total value.  

In light of Einhorn's large position in Apple, and his hourlong presentation last Friday, in which he discussed how Apple can unlock the value of its cash, he definitely believes that the compay has excess cash it can give to investors. In fact, in his presentation, he asserted that Apple can issue preferred shares priced at $32, yielding 4%, without even touching its war vault of over $100 billion in cash. No wonder he has such a large position in Apple!

Some perspective
Though Apple's $137 billion cash hoard receives all the attention, Apple's earning power is really driving the company's need to increase its dividend.

To illustrate Apple's fortunate cash problem in terms of earnings power, imagine an extremely bearish scenario in which Apple's trailing-12-month free cash flow, or FCF, increases only 3% in 2013. After that, it begins to actually decline for the next six years, when it finally levels out at about $32 billion per year:

Year

Growth Rate Estimate

FCF Estimate

Dividends

Cumulative FCF

2013

3%

47.7

$10

$38

2014

(10%)

42.9

$10

$71

2015

(8%)

39.5

$10

$100

2016

(7%)

36.7

$10

$127

2017

(6%)

34.5

$10

$151

2018

(5%)

32.8

$10

$174

2019

(3%)

31.8

$10

$196

2020

0%

31.8

$10

$218

2021

0%

31.8

$10

$240

2022

0%

31.8

$10

$261

The far right column in the table above illustrates the cumulative FCF over this 10-year projection. Though management would undoubtedly spend some of this FCF, the accumulation illustrates that even in this bear scenario, Apple has more than enough cash to run the business. Keep in mind that my quick back-of-the-napkinFCF is equal to cash from operations minus capital expenditures, or cap ex. So this scenario leaves room for Apple to continue to invest $10 billion annually in cap ex, as Apple plans to do in 2013.

But even if Apple doubles its dividend tomorrow, the company still runs into a fortunate cash problem. All else equal to the chart above, doubling the dividend payout to $20 billion annually over the next 10 years yields the following cumulative FCF estimate:

If this isn't convincing enough, Apple's earning power appears even more lucrative when compared to other megacap cash cows.

Company

FCF-to-Sales

Price-to-FCF

Forward P/E

Apple

28.1%

8.9

8.0

Google

26.6%

19.6

15.9

Intel

14.7%

12.8

9.6

Starbucks

10.3%

28.5

20.40

McDonald's

14.3%

4%

14.80

Source: Morningstar.

The other two metrics are both ways look at how the market is valuing a company's earning power. Price-to-FCF, for instance, is equal to a company's market capitalization over its 12 trailing months' FCF. The lower it is, the cheaper the stock. Forward P/E is simply a measure of price over next year's EPS estimates.The FCF-to-sales metric shows the cold, hard cash a company earns on every dollar of sales. It's one way to measure a company's profitability. Of the five cash cows listed above, Apple is the most profitable, with an impressive FCF-to-sales ratio of 28%.

Apple's earning power, therefore, is available at a substantial discount to its peers when measured by both of these metrics. Taking price-to-FCF as an example, the market values Starbucks and Google's FCF as more than three and two times more valuable than Apple's, respectively. Does this substantial premium for Google and Starbucks make sense? Maybe. But it highlights the market's extremely cheap valuation on Apple's ability to throw off cash.

Will Apple's "active discussions" lead to action?
Less than a year ago, Apple announced a plan to return $45 billion to shareholders in the form of dividends and a share repurchase program. Already, the company has returned $10 billion. But with $23 billion in cash flow from operations in Apple's first quarter alone, investors are eager for a larger payout. In fact, a Feb. 7 statement by Apple asserted that "Apple's management team and Board of Directors have been in active discussions about returning additional cash to shareholders."

Fellow Fool Evan Niu took the statement even further: "Make no mistake: Apple has to increase its payout. It simply has no choice at this point, since the company has acknowledged it has more cash than it needs."

So, yes, Apple's "active discussions" will lead to action. But whether or not this action will occur on Wednesday or not is still up in the air. Even so, the all-important questions regarding the details still remain: What exactly will Apple do? In what way will it return cash to shareholders? How much? We'll likely know more tomorrow.

There's no doubt that Apple is at the center of technology's largest revolution ever, and that longtime shareholders have been handsomely rewarded with over 1,000% gains. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple, and what opportunities are left for the company (and your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.


Read/Post Comments (2) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 26, 2013, at 4:45 PM, GWFHegel wrote:

    I mistrust Einhorn. Apple is his biggest holding -- so, if he gets them to promise a bigger dividend, his stock soars. I think this is price manipulation through large size -- doing what is in the short term best interest of the hedge fund, not the long term best interest of the company.

  • Report this Comment On February 26, 2013, at 4:52 PM, techy46 wrote:

    Split the stock 4 for 1 soi that it still qualifies for the new mini call options going into effect on 3/13/2013, raise the dividend to 3-3.5% to get rid of some of the excess cash and institute a $20-30 billion stock buy back. That will put the new stock at $125-130 PS.

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