Will Apple, Inc.'s 2015 Capital Return Update Be a Major Disappointment?

Investors are now less than two months away from Apple's (AAPL 0.64%) forthcoming update to its capital return program, which the Mac maker will detail alongside first-quarter earnings in late April. I personally consider the update potentially an even more important catalyst for 2015 than Apple Watch, which also ships in April.

However, shareholders expecting a massive boost could be in store for a major disappointment instead. At least, that's what UBS analyst Steven Milunovich thinks. The analyst released a research note earlier this week outlining his thoughts on why Apple's imminent capital return update could be a let-down relative to current expectations. Milunovich has some compelling arguments. Let's dig in.

Operating cash flow is not enough
Apple now generates over $50 billion per year in operating cash flow; even free cash flow was nearly $50 billion last fiscal year. Incredibly, Apple's capital returns in fiscal 2014 were 112% of free cash flow. However, consolidated cash flow figures only paint part of the picture.

Source: SEC filings. Fiscal years shown.

Since Apple can only use domestic cash reserves to fund its capital return program, we must look at domestic cash flow. This also includes the cash Apple has raised through its debt issuances in recent years. Because of the sheer size of Apple's repurchases, domestic cash continues to dwindle as the Mac maker accumulates increasing amounts of debt.

Source: SEC filings. Fiscal quarters shown.

Apple can certainly afford to continue issuing debt to fund share repurchases, since current interest expense is easily offset by other types of income (among other reasons), but there's still an eventual limit to how much debt Apple can or should take on. That's particularly true assuming Apple wants to keep its pristine debt rating, making sure it can still get low rates when it does decide to issue bonds.

If only there were some way to bring some of its foreign reserves home...

Thanks, Obama
Milunovich points out that Apple could potentially be waiting for an opportunity to repatriate some of its foreign cash. There are several different possibilities floating around Capitol Hill right now that could potentially pave the way for Apple to bring some cash home.

Earlier this month, President Obama proposed to levy a mandatory 14% tax on overseas cash as part of his fiscal 2016 budget and then apply a 19% tax on foreign earnings going forward. If the proposal is approved (it will face stiff opposition from across the aisle), it would result in a hefty tax bill for Apple. But importantly, it would close the tax loophole that encourages U.S. multinationals to keep cash abroad in the first place. U.S. companies are able to defer taxes on foreign earnings that are "indefinitely reinvested" abroad. This vague language is precisely why many companies keep cash abroad "indefinitely." If this loophole were closed, Apple (and many other companies) would have no reason to avoid repatriating vast sums of cash.

The other scenario on the table involves a temporary repatriation tax holiday that could allow companies to bring home cash at favorable rates. Congress would use any related tax revenue to replenish the Highway Trust Fund. Apple has been lobbying for broader tax reform for years, and it easily has the most foreign cash of any U.S. multinational.

The point here is that there's still a fair amount of uncertainty, and Apple may simply choose to wait and see how things play out in Congress. Sadly, we all know how long that can take. In the meantime, the company might play it conservatively with capital returns until it can get greater visibility into its tax situation on foreign reserves.

Taking a breather
Milunovich estimates that Apple's share repurchases "could be as low as" $20 billion throughout the calendar year. That sum is still massive in the grand scheme of things compared to other companies, but it's small relative to Apple's current $130 billion program (including dividends and share repurchases), which was implemented in 2012 and expanded several times. Here's how much cash Apple has returned to investors in recent fiscal years.

Source: SEC filings. Figures may not sum due to rounding.

Apple's capital return program will remain the largest in corporate history, but it might very well take a little bit of a breather in 2015.