In the post-2008 financial world, debt is universally associated with evil. One of the most commonly utilized means to analyze companies is to inspect balance sheets to make sure they don't have a burdensome amount of debt on the books. This obviously makes a great deal of sense, since there are indeed plenty of companies that take on too much debt and are worse off later on.
Technology giant Apple (NASDAQ:AAPL) isn't one of those companies, however. It's taken on a lot of debt in a series of sales that began last year, but it's the right move. Apple is set to offer billions more in debt, which may have you worried about the company's financial strength going forward. However, in Apple's case, there's very little to worry about. In fact, the move to issue debt will come as a benefit to both the company and its investors, and is the right strategy for management to take.
Sterling balance sheet isn't currently benefiting shareholders
By now, most people know that Apple has a ton of cash, $150 billion in cash and marketable securities to be exact, which is a very good thing. But, what you might not know is that Apple is getting almost no credit for its cash hoard, which isn't such a good thing. That's because Apple's valuation remains at a significant discount to both the broader stock market and its peer group, even with such an impressive cash balance.
This is true even following its run-up after posting strong earnings, in which the company reported nearly 5% revenue growth and double-digit earnings growth. Still, Apple trades for just 13 times forward earnings estimates, while the broader market holds a forward multiple close to 20 times earnings. After stripping out its huge cash pile, the result is even more striking. Apple's valuation based on its enterprise value, which incorporates a company's cash hoard while deducting its net debt, is even cheaper. Using this measure, Apple trades for an enterprise value to EBITDA ratio of just 8 times.
It's time to monetize
Apple clearly needs to do something with its cash pile for the benefit of shareholders because the market is giving the company no multiple premium for it. In this situation, companies often turn to huge acquisitions. Apple does indeed acquire companies, several of them per year. But, management has indicated little desire to go on an empire-building spending spree just for the sake of making news. That may prove to be a shrewd move since there are abundant examples of companies overspending on acquisitions only to have to write down those assets later.
Instead, Apple is investing in research and development, buying back stock, and raising its dividend. Those latter two points should be emphasized. Apple recently announced it would expand its total capital allocation program by $30 billion, to $130 billion, which will be delivered via buybacks and dividends. Since a lot of Apple's cash is held overseas, due to the fact that two-thirds of the company's revenue is derived internationally, Apple would incur a significant tax liability if it chose to repatriate that cash. That's where bond sales come into play.
Last year, Apple sold $17 billion worth of bonds, which represented the second-largest offering ever. This time, Apple will sell $12 billion of debt. While $29 billion in debt seems like a worrisome amount, it's pocket change for Apple. Plus, Apple is such a profitable company and is in such a fantastic financial position that the cost of this debt is a pittance. Apple holds a AA+ credit rating from Standard and Poor's, which is its second-highest possible rating. As a result, Apple's varying maturities included 10-year fixed rate notes that were priced just 77 basis points over comparable U.S. Treasuries.
The bottom line
It's easy to worry about a company taking on tens of billions of dollars in debt. After all, one of the harsh lessons learned in the financial crisis is that debt has the power to bring an entire economy to the brink of collapse. However, it's also possible for a company to utilize debt to its advantage, and that's what Apple is doing.
It became clear that the market wasn't going to give Apple a premium valuation for its cash pile since that cash was earning almost nothing for shareholders. By issuing extremely low-cost debt to fund its dividend increases and share buybacks, Apple is providing an instant return to shareholders. That's why you shouldn't be at all concerned about Apple's bond sales.
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Bob Ciura owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.