Credit Suisse’s Kulbinder Garcha this morning reiterates an Outperform rating on shares of Apple (AAPL) while raising his price target to $600 from $550, writing that his “deep dive” into Apple’s free cash flow could allow for $62 billion in “excess cash” onshore (as opposed to cash held overseas) over the next four years, providing for a dividend and buybacks, should Apple decide on such.
“This is sufficient to fund a dividend of greater than $10 per share or a 2.1% yield (in line with the S&P) as well as leave $22.5bn for cumulative buybacks over 2012-2015 on a sustainable basis,” writes Garcha. Garcha uses a “payout ratio” of 20% for a theoretical dividend, which is half the S&P long-term average, he notes. A 2.1% dividend yield, moreover, would be way higher than the 0.6% average yield of tech companies.
“Furthermore, our analysis is conservative as it assumes no further major product introductions, discounts offshore cash completely for distribution purposes (amounting to as much as $186 per share by 2015), and lower FCF conversion.”
Garcha asks the question he thinks everyone is asking, namely, “can a $475bn company actually outperform?” At this size, Apple is 3.9% of the Standard & Poor’s 500 Index. At that size, which very few megacaps have achieved, Apple has been “de-rated,” he writes, its forward P/E multiple dropping from 24 times to 10 times in the last decade.
He thinks the real barrier for Apple’s performance comes at $650 per share, when it would be 5% of the S&P 500.
Garcha’s analysis assumes revenue growth of 40% this year, 23% next year, 4.6% in 2014, and 10% in 2015. That would result in free cash flow of about $45 billion per year, for a total cash horde of $280 billion by fiscal 2015 ( the fiscal year ending in September), “in the event of no cash distribution.”
Assuming Apple’s gross margin remains relatively higher overseas than in North America, which it is now, and assuming the bulk of the company’s capital spending happens overseas in coming years, as it does now, Garcha estimates Apple would have $94 billion in cash in the U.S. by 2015.
Using the standard metrics for excess cash, Garcha concludes Apple will have $62 billion of cash it doesn’t need for operations come 2015, though he stops short of asserting the company will do something:
This level of cash held in the US is from where we believe Apple will consider making cash distribution to shareholders. While in traditional finance theory holding any net cash pile on balance sheet is seen as being inefficient, in the tech sector it seemingly does not apply. Whether this is due to fast product cycles or the risk around sustainable competitive advantage, the fact remains that on average, technology companies have a net cash position of about 34% of global sales which is slightly higher than Apple’s ratio of onshore cash to onshore sales of 29%. Assuming Apple over time migrates to similar averages (although this could prove conservative), this would still mean that even domestically Apple may hold excess cash of around $62bn in the long term. This is the amount that we believe the company could distribute to shareholders over the long term (this would amount to ~$16bn of cash distribution per annum).
In fact, Garcha makes a long defense of the other uses Apple has for cash, including any attempt to manufacture a television set:
The global manufacturing logistics surrounding the production of a television set are fundamentally different than those required for Apple’s existing product offerings. Many countries classify TVs under a different category for tariff purposes, resulting in higher import fees if the majority of its components are manufactured offshore.
Apple shares today are down $3.82, or 0.7%, at $511.25.