Apple (NASDAQ:AAPL) stock slumped on Friday, after the company's earnings report showed that iPhone shipments declined modestly last quarter. While Apple had benefited from an extra week during the same quarter a year earlier, investors had been hoping that the recent iPhone X launch would drive a "super-cycle" of rapid iPhone sales growth.
Apple's second-quarter forecast also missed expectations. The company expects to generate $60 billion to $62 billion of revenue this quarter, compared with an average analyst estimate of $65.7 billion.
Fortunately, the news wasn't all bad for investors. Apple's second-quarter guidance -- and management's commentary during the earnings call -- confirmed that the company will receive a huge EPS boost from U.S. tax reform.
Apple's tax rate will plunge
Tech investors had a mixed reaction to the prospect of tax reform in late 2017, because it wasn't clear how much the average tech company would save. Last year, the technology sector had an effective tax rate of 18.5%, according to Bloomberg. That was already well below the old 35% statutory federal corporate tax rate -- and even below the new 21% statutory rate.
However, Apple has had a higher effective tax rate than many of its tech peers. Over its past three fiscal years, Apple's effective tax rate has averaged 25.5%. Last quarter, its effective tax rate was slightly higher at 25.8%.
By contrast, Apple projects that its new effective tax rate will plunge to 15%. This is less than the new statutory rate, primarily because Apple's international earnings will no longer be subject to U.S. taxes.
Taking 25.5% as Apple's baseline tax rate -- and holding pre-tax income constant -- reducing the effective tax rate to 15% would boost after-tax earnings by 14%.
Time to ramp up the buyback machine?
The other major benefit of tax reform for companies like Apple is that they will be able to repatriate their foreign cash at a lower tax rate. The tax law imposes a one-time 15.5% tax on cash and liquid investments held overseas. Apple ended last quarter with about $285 billion of cash and investments -- nearly all of which is held outside the U.S. for tax purposes. As a result, it expects to pay $38 billion of repatriation taxes under the recent law.
However, that still leaves it with a huge amount of excess cash. On the earnings call last week, Apple CFO Luca Maestri stated that the company will aim "to become approximately net cash neutral over time."
Apple does have more than $100 billion of debt. Still, its net cash position was $163 billion at the end of last quarter. Even if it reserves $38 billion for the repatriation taxes it will have to pay, that would leave $125 billion of excess cash. Given that Apple has consistently shied away from major acquisitions, it seems likely to return most of this cash to shareholders sooner or later.
Assuming Apple uses all of the $125 billion on share repurchases, it would be able to buy back about 779 million shares at the stock's Friday closing price of $160.50. That works out to more than 15% of the company's shares.
Even if Apple had to pay an average price of $200 for its share repurchases, $125 billion would be enough to buy 625 million shares. That would reduce Apple's share count by more than 12%, boosting EPS by 14%.
Adding it all up
Thanks to the magic of compounding, the combination of a 14% lift from a lower effective tax rate and a 14% lift from a lower share count would boost Apple's EPS by 30% for any given level of pre-tax income.
Applying this 30% bump to Apple's EPS for the past four quarters would increase its trailing EPS to $12.65. Apple stock trades for less than 13 times this adjusted earnings figure. Even if the company has to settle for slower growth in the years ahead, the stock is still cheap compared with most of the alternatives.