After Intel (NASDAQ: INTC ) reported a mediocre quarter, the company announced a seventh straight quarterly dividend of $0.225 per share. With no dividend raise in 2013, investors holding Intel for its dividend were likely disappointed by the news. A year ago, Intel seemed like a dividend investor's dream, with a yield near 4% and a history of solid dividend growth. But that yield has fallen as the share price has risen, and without any indication of when dividend growth will restart, alternatives like Microsoft (NASDAQ: MSFT ) and Apple (NASDAQ: AAPL ) look more promising.
Follow the money
A company's dividend is paid out of the operating cash flow, and in order for the company to raise the dividend, one of two things need to happen. Either the percentage of the operating cash flow going toward the dividend needs to increase, or the operating cash flow itself needs to increase.
Capital expenditures, which is the amount of money a company uses to buy equipment, property, etc., also comes out of the operating cash flow. Capital expenditures represent a company's investment in itself, with the idea that the added investment should generate a return for the company in the future in the form of additional operating cash flow.
The above chart shows both Intel's capital expenditures and dividend payments as a percentage of the operating cash flow over the past decade as well as share buyback activity. After growing rapidly for a few years, the dividend reached the low-20% range and, with the exception of the financial crisis years of 2008-2009, has stayed there ever since. Meanwhile, capital expenditures shot up dramatically in 2011, remaining elevated through today.
Intel has been investing heavily in order to maintain its technological lead. Unlike many chip designers that outsource manufacturing, Intel manufactures its own chips. This allows Intel to achieve extremely high margins by cutting out the middle man, but constantly building new fabrication plants in order to stay one step ahead of the competition is a costly endeavor.
Part of this investment has been a push to create chips which can compete with ARM-based competitors in the mobile market. Intel has traditionally focused on PCs, where power consumption isn't as important as raw power, but the mobile market is very different. The first tablets and convertibles powered by Intel's low-power Bay Trail processors hit the market at the end of 2013, before which Intel's mobile offerings were lackluster at best.
The decline of the PC market, along with Intel's sluggish entry into the mobile market, has left operating cash flow at a standstill even as capital expenditures have shot through the roof. The payoff for Intel is just beginning, with the company targeting a quadrupling of its mobile chip sales this year, but it will be at least a few years before the division starts to turn a profit. Currently, the mobile-chip division is losing about $2.5 billion per year in operating income, and that may rise in 2014 as Intel offers incentives to OEMs in order to push adoption of its mobile chips.
What Intel's left with, then, is a PC division which will be flat in terms of profit at best, a server division that Intel expects to grow in the double digits but grew more slowly in 2013, and a mobile division that is eating a significant chunk of the company's profits. It's clear that operating cash flow will only begin to meaningfully rise once the mobile business hits critical mass, which is certainly not going to happen this year.
This means that the dividend is probably stuck for a while at current levels, unless capital expenditures come down further than they already have. The dividend growth story at Intel isn't dead, it's just in a coma, and it will be a few years before it has a real chance at waking up. I like Intel's long-term story, but the next few years will be challenging for the company and investors.
Microsoft and Apple as dividend alternatives
Big technology companies have started to embrace dividends over the past few years, with both Microsoft and Apple rapidly growing their respective dividends. Microsoft currently pays a 3.1% dividend based on its most recent payment, and in fiscal 2013 only 26% of the operating cash flow went to dividends. Since Microsoft's business isn't nearly as capital intensive as Intel's, there's plenty of room left over to grow the dividend further. The latest dividend increase at the end of last year was a nearly 22% hike, and I expect Microsoft to continue to push its dividend higher over time.
Apple is fairly new to the dividend game, reintroducing a dividend in fiscal 2012 after a 17-year hiatus. Apple's dividend yield is much lower than Microsoft's at just about 2.2%, but the company paid out less than 20% of its operating cash flow as dividends in fiscal 2013. Like Microsoft, Apple is less capital-intensive than Intel, meaning that this percentage can safely rise much higher.
One thing that Microsoft and Apple have that Intel doesn't is an enormous pile of cash. While Intel has spent most of its excess cash on share buybacks over the years, leaving a small net cash position, Microsoft and Apple have enough cash laying around to buy back a significant fraction of outstanding shares. By reducing the share count, buybacks reduce a company's total dividend payment, allowing it to boost the per-share dividend without raising the payout ratio. While both Microsoft and Apple can fund buybacks exclusively from their cash hoards for years to come, Intel would have to take on additional debt.
The bottom line
Intel's failure to raise its dividend is the result of heavy investments made over the past few years just starting to pay off. The next few years will be challenging as Intel attempts to bring its mobile business into profitability, and only once it reaches a critical mass will the dividend see any substantial increases. The dividend growth story at Intel is not dead, but it is a long-term story, and I doubt we'll see much of an increase this year or next.
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