Apple (AAPL) is a blue chip stock that recently reinstated the dividend. Since becoming a dividend payer again in 2012 (it was suspended from 1996-2011), they have increased the quarterly dividend by 50% from 38 cents per share to 57 cents.
With a relatively low payout ratio, high returns on invested capital, and an extremely valuable consumer brand, Apple looks undervalued at only 13x 2016 earnings. Warren Buffet’s lieutenants certainty agree as Berkshire Hathaway (BRK-A) invested over a billion dollars in the company this year.
However, in a world where technology trends change drastically quickly, should investors count on Apple to deliver sustainable dividend growth?
Business Analysis
Apple is a global technology company with a rich history of product innovation. In fiscal year 2015, they generated sales of roughly $234 billion dollars. To put some context around this colossal sales number, it is larger than the GDP of many countries.
In general, the technology industry is a difficult industry to invest in for dividend investors due to the speed at which trends can influence competitive positions.
The same factors that have allowed Apple to be extremely successful could just as easily go against the company if a competitor were to come out with a far superior product or if a new innovation were to displace the iPhone entirely.
Besides paying attention to all the usual important financial ratios, dividend investors need to pay attention to the sustainability of the current margin structure, projected key product growth rates, and Apple’s capital allocation.
Apple operates the business through key product lines including the iPhone (66% of sales), iPad (10%), Mac (11% ), Services (8.5%), and Other Products (4.5%).
Apple generates enviable economics with returns on invested capital significantly above its cost of capital driven by 30%+ operating margins.
Source: Simply Safe Dividends
Margins have significantly increased from around 12% in the pre-iPhone years close to a decade ago. In fiscal year 2006, Apple’s main sources of revenue came from the Mac and iPad. Clearly the economics of the business have changed with the introduction of the iPhone.
Source: Simply Safe Dividends
Some reports put the gross margins on the iPhone 6 at nearly 70%. This is a huge margin and obviously helped drive up the company-wide margins well into the 30% range.
Furthermore, Apple’s margin is well in excess of estimated Android phone manufacturer (HTC, Sony, LG, Samsung, etc) margins of flat to 10%.
The only reason Apple can generate such a superior economic profile relative to peers has to be due to brand power, capturing the full economics of the phone (software and hardware), better terms from suppliers, or a superior product. In fact, it is likely that they benefit from all of these factors.
Given the current business mix and way the business has evolved over the past decade, the sustainability of iPhone margins are the key to maintaining the robust operating profile.
Clearly this could change if Apple develops a breakthrough new product or service. After all, few predicted back in the early-to-mid-2000s that smartphone adoption would take off like it did and that Apple would be the one to capture the majority of the value from the market.
Assuming that the business mix remains the same, the key to the sustainability of the current operating profile and future dividend increases is maintaining the iPhone economics.
