With rising interest rates, is Apple Inc's $100 billion debt a problem for AAPL stock?
Since its near-death experience in the 1990s, Cupertino-based tech giant Apple Inc (NASDAQ:AAPL), which is one of the greatest cash machines in corporate history, has been rather conservative when it came to its finances and balance sheet. The MacBook maker had hardly any debt on its balance sheet throughout Steve Jobs' second stint as its CEO, and invested all its cash in highly liquid U.S treasuries. Apple Inc was also very conservative in rewarding investors through dividends and stock buybacks. Back in 2010, Reuters published an article titled "Cash-rich Apple's CFO may have world's best job" describing Apple's conservative financial practices.
Apple Inc is returning billions of dollars through dividends and stock buybacks.
However, in the last five years, there have been gradual changes in how Apple manages its cash. From being a company which didn't believe in dividends and stock buybacks, the company is returning billions of dollars to its shareholders every quarter. The change in Apple's dividend philosophy occurred after Tim Cook took the helm of Apple Inc from Steve Jobs. Of course, the new management needed a push from activist investors like Carl Icahn and David Einhorn to set a cash return policy. Steve Jobs had earlier resisted similar calls to return cash to investors.
In 2013, Apple announced a plan to return a total $100 billion via dividends and buybacks by 2015 which was later increased to $200 billion. In August 2016, Apple's board decided to increase the limit of its capital return program from $200 billion to $250 billion. Since 2012, when it issued dividends for the first time under Tim Cook, Apple has returned nearly $200 billion in capital to its shareholders. In all, Apple Inc has paid around $52 billion in dividends and has returned around $146 billion through stock buybacks. Apple also raised its quarterly cash dividend by 10% from $0.52 to $0.57 per share. Apple is expected to continue raising its dividends going forward.
Apple Inc's debt is near $100 billion and rising.
One of the consequences of Apple's aggressive capital return policy has been the rising level of debt on Apple Inc's balance sheet. Apple recently issued $10 billion worth of commercial papers due to the outflow of $11 billion owing to its stock buyback program. At the end of 2012, Apple had zero long term debt on its balance sheet. However, since then the line item of long term debt on Apple's balance sheet is printing bigger and bigger numbers. Apple reported long-term debt of $77.4 billion in the quarter ending December 31, 2016. Overall, including commercial papers, Apple Inc has nearly $100 billion in debt. Such a high amount of debt increases the risk of the balance sheet, especially in a rising interest rate scenario.
Apple has around $8 billion in floating rate notes (periodic adjustment of interest rates). Considering that we are currently in a rising interest rate scenario, with the Fed expected to raise interest rates by 50bps-75bps by the end of the year, the interest liability of Apple on these floaters is likely to rise. Rising interest rates also bring re-financing risks for Apple. Apple is scheduled to repay around $10 billion dollars in the next couple of years. If Apple decides to refinance these loans it will have to pay higher interest. Already interest rates are inching up. The weighted-average interest rate of Apple's Commercial Papers rose from 0.45% in September to 0.61% as of December 31, 2016.
Rising debt and interest rate don't pose a threat to Apple's financials.
However, given Apple's strong operating performance and its cash position, rising interest rates may not pose a big threat to Apple for now. A 100 basis point increase in market interest rates would cause interest expense to increase by $271 million on an annualized basis, which is a fraction of Apple's quarterly cash flows. But given that its domestic cash balance is declining, unless President Trump keeps his promise related to repatriation of cash, the perceived riskiness of Apple's bonds will increase. For now, though, rising debt levels and interest rates don't pose any material threat to Apple's financials. Apple Inc stock is part of our Top Stock Picks from the technology sector, which have outperformed the NASDAQ by around 140%.