A Big Bite Of The Apple? by Kirk Moore, Head of Global Fixed Income Research, ColumbiaManagement
- We believe that the investment-grade universe has an adequate capital structure that balances shareholders and debtholders, suggesting the credit cycle is in the middle of the expansion stage.
- While Apple’s rise in debt has significantly outpaced its earnings growth, this is an appropriate capital structure for a maturing company.
- We are concerned about anemic investment and top-line growth, but corporate America has tremendous operating leverage following six years of thoughtful expense reduction.
Last week, we highlighted CSX management’s decision to debt finance the increase in its share buyback program, noting that the railroad was one of the first old-line industrial companies to embark on this strategy. The descriptor “old-line” was purposeful, as the new breed of investment grade corporate bond issuers began instituting debt-financed share buyback programs two years earlier. As the business models of technology companies such as Apple, Microsoft, Cisco and Oracle matured and began to generate sustainable free cash flow, introducing debt into the capital structure became reasonable. In May 2013, Apple issued its first publically traded corporate bonds following the announcement of two-year $60 billion buyback program. In total, the company earmarked $100 billion in shareholder returns through 2015.
Fast forward to last week’s (4/27/15) fiscal-second-quarter announcement where the company boosted its return to shareholders through 2017 to $200 billion ($140 billion in buybacks and $60 billion in dividends). That staggering sum is a 54% increase over the company’s prior plan. Apple’s earnings were front page news in the next day’s The Wall Street Journal, but it took until the second page and eight paragraphs for the Journal to lend some perspective. The return to shareholders is larger than the market capitalization of all but 15 of the members of the S&P 500 Index. Is this another signal that the downturn stage of the credit cycle is approaching?
Since 2012, the growth in Apple’s debt (+232% 2013-2016e) has outpaced that of its earnings before interest, taxes, depreciation, and amortization (EBITDA) (+43.5%) by a significant amount, ultimately increasing over $56 billion by year-end 2016 (Exhibit 1).
Exhibit 1: Apple total debt vs. EBITDA
Sources: Company financials, Columbia Threadneedle estimates, 05/15
While Apple’s debt has grown rapidly, the company’s leverage metric (debt/EBITDA) is still well below that of its technology and Industrial peers (Exhibit 2). So while the headline shareholder amount is a bit mind numbing, Apple’s ability to generate earnings and ultimately cash (estimated to be $216 billion at fiscal year-end 2016) supports a significant increase in debt in its capital structure. As CEO Tim Cook stated on the company’s earnings call, “We’re in the very fortunate position of generating more cash than we need to run our business and keep making these important investments. So today, we’re announcing another significant update to our capital return program expanding its size to $200 billion through March of 2017.”
Exhibit 2: Apple’s debt/EBITDA is still well below that of its peers
Sources: Company financials, Columbia Threadneedle estimates, 05/15
We believe that the investment-grade universe has an adequate capital structure that balances shareholders and debtholders, suggesting the credit cycle is in the middle of the expansion stage. And while Apple’s rise in debt has significantly outpaced its earnings growth, this is an appropriate capital structure for a maturing company. However, it is a bit unsettling that a company as innovative Apple cannot find more significant reinvestment opportunities. Anemic investment and top-line growth by corporations are a concern, especially if they persist. However, the Fed’s efforts to stimulate economic growth should help unlock corporate America’s tremendous operating leverage following six years of thoughtful expense reduction.
