does apple finance
The Thing About Apple's Euro Debt
- Apple finances its shareholder returns via debt it issues at low rates.
- Issuing debt denominated in Euros is preferable. Apple did so last Wednesday.
- Apple can save hundreds of millions in interest expenses.
- Apple gets a free currency hedge on top.
Apple (NASDAQ:AAPL) has, over the last year, issued a substantial amount of debt in order to finance the company's share repurchases and dividends. Most of that debt has been denominated in US dollars, but Apple has issued debt denominated in Euros as well - this provides a couple of additional benefits. Since Apple has just last week issued Euro denominated debt worth billions of dollars, let's take a closer look.
Apple's share price of $153 is just slightly below the all-time high, after the company's shares had a very big run up over the last couple of months. Apple's twelve-month performance stands at a staggering 65% - a great success for a company of Apple's size.
One reason for Apple's strong performance over the last year (as well as before that) is the rapidly shrinking share count it is experiencing - over the last five years, the company's number of outstanding shares has dropped by almost 1.5 billion, or more than 20%. In order to finance this share repurchase program (on which Apple has spent $34 billion in just the last year, not counting in the dividend yet), Apple has taken on a big debt position, as most of the company's cash is positioned offshore and thus not available for share repurchases.
Apple's long-term debt now totals close to $100 billion, which is a substantial amount, yet overshadowed by the company's $260 billion cash hoard.
Issuing new debt in order to finance stock buybacks, acquisitions, dividends and so on has been a favorite of many multinational companies over the last years, and as long as those companies have big cash positions overseas, there is nothing wrong with that - the balance sheet still is very solid and the interest rates these companies have to pay are rather low. In Apple's case, the weighted average interest rate is 3.3%.
In order to get to the actual net cost of Apple's debt, we have to lower this rate by Apple's tax rate, since higher interest expenses lead to lower pre-tax profits and thus lower Apple's tax expenses, which partially offsets the impact of higher interest expenses. Multiplying the 3.3% average yield with (1-0.26) gets us to a net cost of 2.4%.
In the US, interest rates have been rising over the last one and a half years, with the effective fed funds rate hitting five-year highs of very close to 1% recently. Interest rates are expected to continue to rise further, with two more rate hikes this year being considered as the most plausible scenario - at the same time, the Eurozone still has a central interest rate of 0.0%.
The impact is that debt is currently a lot cheaper when denominated in Euros, which holds true for corporate debt as well - even when the issuer is not based in the Eurozone, as is the case with US-based Apple.
The exact rates for the Euro denominated debt Apple issues last week hasn't been announced yet, but from past debt issuance in the same currency, we know relatively well how cheap that debt can be for Apple: In 2015, Apple sold paper maturing in 2027 at a rate of less than 2%. The debt that was issued last week in two tranches matures in eight years and 12 years, thus interest rates should be comparable to what Apple paid in the past - after all, central rates in the Eurozone did not increase (they actually went down by 0.05 percentage points).
For a worst case, let's calculate with a rate of 2% - this gets us to a net cost of 1.5%.
When we only look at the interest cost for the $5.5 billion worth of debt that was sold last week, we get to the conclusion that Apple saved about $550 million in net financing costs by issuing in debt denominated in US dollars rather than in Euros.
There is, however, another benefit of issuing debt in a foreign currency - it is a method of hedging against unfavourable currency rates. Let's look at what can happen to the €5 billion Apple has issued last week: That debt was converted to $5.5 billion (at the current rate), money that can be used for stock buybacks or for paying Apple's $13 billion per year dividends. When the debt matures in 10 years, there are three possibilities for the €:$ rate:
- The rate is the same as it is right now; in this case, there was no impact, except for the lower interest cost.
- The Euro is stronger than it is today; in that case, Apple would have to pay more than $5.5 billion in order to get €5 billion, i.e. it would lose money in that transaction, but at the same time a stronger Euro would mean that Apple's European operations would be earning a higher amount of money for the company - the contrary to the negative impact of the strong dollar we have seen in many earnings releases of American companies over the last few years.
- The Euro is weaker than it is today. In that case, Apple's European operations would contribute a lower dollar amount to Apple's top and bottom lines than they do right now, but that is true even if Apple does not hold any debt denominated in Euros. It is, however, cheaper for Apple to get the €5 billion the company has to pay back to the holders of its debt, thus Apple makes money on that transaction.
By issuing debt in other currencies (Euros in this case), Apple can thus hedge against unfavourable currency movements: A dollar that gets stronger (which hurts Apple's foreign operations) leads to a currency gain, which partially offsets the adverse effect of declining foreign currencies. Usually companies have to pay for hedging their foreign currency exposure; Apple gets access to that hedge for free while at the same time saving hundreds of millions of dollars in interest expenses. The combination of these two factors makes Apple's foray into Euro-denominated debt a very good idea, one Apple should employ more often.
Apple does what many companies are doing: Issuing debt in order to finance shareholder returns, while at the same time holding a lot of offshore cash that secures the company's debt.
By issuing debt denominated in Euros, as Apple did last week, the company gets some additional benefits versus issuing debt denominated in dollars: Lower interest costs and a free hedge against adverse forex movements, a combination that makes Euro debt a great idea.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
CFA Institute Inside Investing Providing insight for investors
One of the more interesting and insightful models or systems in financial analysis is the DuPont analysis, named after the U.S. chemical company that began systematically looking at these numbers in the 1920s.
The DuPont analysis is a way of decomposing and examining the financial ratio return on equity (ROE). ROE looks at how much a company earned in the previous period compared with the total amount of owners’ equity invested in the business. The DuPont analysis looks at why ROE is what it is and identifies some of the underlying drivers of the ratio.
One of the nice things about the DuPont analysis is that all the numbers can be taken straight from the income statements and balance sheets provided by companies in their quarterly and annual earnings releases or SEC filings. For our purposes, we are using the most recently filed Form 10-K annual report for Apple, Inc., dated 29 September 2012.
A DuPont analysis begins with the company’s return on equity (ROE). The formula for that is ROE = Net Income/Equity, as below:
When calculating financial ratios that mix balance sheet numbers with income statement numbers like this one, it’s important take an average of the beginning and ending balance sheet numbers for the period, which is what we have done here.
The reason for this approach is that income statements look at activity that happened over the entire period, whereas balance sheets are “snapshots” of the company on one particular day at the end of the period.
So, their return on equity was 42.84%. What does that mean?
Good question. It means that Apple earned almost $42 billion in the most recently ended fiscal year. That’s way more than I earned last year. They did that while having average invested owners equity in the business of $97.4 Billion.
Many investment professionals choose to look at this by comparing the opportunity to invest in this business with some other alternatives. They could have had that $97.4 Billion invested in short term Treasury Bills last year and would not have made nearly as much.
The question is WHY or “how” did they earn that 42.84% return on the capital they had invested. Was it because management was efficient? Because they had high financial leverage? What drove that number?
Decomposing Return on Equity
It turns out that we can decompose or break ROE down into component parts through a mathematical identity.
ROE = Net Income / Equity = (Net Income/ Sales) * (Sales / Assets) * (Assets / Equity).
This works because it’s an identity:
Net Income / Equity = (Net Income / Sales) * (Sales / Assets) * (Assets / Equity).
Extracting Information from the Component Pieces
Profit Margin = Net Income / Sales
$41,733 / $156,508 = 26.66%
Profit margin, as the name implies, tells you how profitably you are running the business. Are you barely covering your costs or do you have a pretty good cushion? The more commoditized a product is the slimmer it’s margins will be. Apparently people don’t view the products Apple, Inc. sells as a commodity since 26% is a very comfortably profitable business.
Asset Turnover = Sales / Assets
$156,508 / $146,218 = 107.04%
Asset Turnover measures the amount of sales a company has relative to the assets it has to own and maintain in order to generate those revenues. The amount of turnover can tell us a fair bit about how the business operates. If turnover is high (as it might be at a hot dog stand or supermarket) or low (as it might be at a low turnover business like a car dealership) we can reach different conclusions. To think about how sales work differently in these two lines of business, remember that there are no “10 Items Or Less” signs in a car dealership: customers usually buy just one car at a time.
Financial Leverage = Assets / Equity
$146,218 / $97,413 = 150.10%
Financial Leverage is an indication of how much Debt the company uses to finance the generation of revenues. As we’ll see, Apple, Inc. is in the enviable position of having no long term debt outstanding, meaning it has not had to borrow money to acquire the assets it uses to generate revenues, or has paid any debt back already.
So putting those three component ratios together, we get the basic DuPont Analysis:
ROE = Profit Margin * Asset Turnover * Financial Leverage
42.84% = 26.66% * 107.04% * 150.10%
The Extended DuPont Analysis
It’s helpful to know a little bit more about why the return on equity was 42.84%%, and this gives us some finer details to examine. We can actually do to the first component of the analysis, the Profit Margin Ratio, what we did with ROE. That is, we can break Profit Margin, again using a mathematical identity, into it’s own component parts giving us an even finer level of detail to explore. This is called The Extended DuPont Analysis.
As we have seen:
Profit Margin = Net Income / Sales
26.66% = $41,733 / $156,508
This can be rewritten using another mathematical identity:
Profit Margin = (Net Income / Sales) = (Net Income / Earnings Before Taxes) * (Earnings Before Taxes(EBT) / Earnings Before Interest and Taxes (EBIT)) * (EBIT / Sales)
We can now look at what drove the Profit Margin to be 26.66%.
Tax Burden = (Net Income / Earnings Before Taxes)
$41,733 / $55,763 = 74.84%
Tax Burden is an indication of how much the company is paying in corporate taxes or how much of the profit is falling to the bottom line. This calculation indicates that as of the most recent quarter, Apple kept almost 75% of every dollar they make after expenses.
Interest Burden = (Earnings Before Taxes / Earnings Before Interest and Taxes)
$55,763 / $55,763 = 100%
As mentioned earlier Apple, Inc. has no long term debt outstanding and therefore has no Interest Expense to pay to lenders. This means EBT is the same as EBIT. Usually Interest Expense reduces Net Income and therefore lowers ROE.
Sales Margin = (EBIT / Sales)
$55,763 / $156,508 = 35.63%
Sales Margin is yet another way of looking at how profitable each dollar of revenue is after deducting operating expenses but before deducting interest and taxes.
So again putting the three ratios together we get:
Profit Margin = Tax Burden * Interest Burden * Sales Margin
26.66% = 74.84% * 100% * 35.63%.
And finally the complete Extended DuPont Analysis:
ROE = (Net Income / EBT) * (EBT / EBIT) * (EBIT / Sales) * (Sales / Assets) * (Assets / Equity)
42.84% = ($41,733 / $55,763) * ($55,763 / $55,763) * ($55,763 / $156,508) * ($156,508 / $146,218) * ($146,218 / $97,413)
ROE = Tax Burden * Interest Burden * Sales Margin * Asset Turnover * Financial Leverage
42.84% = 74.84% * 100% * 35.63% * 107.04% * 150.10%
Naturally, as an analyst, it would be a most helpful exercise indeed if one were to perform the Extended DuPont Analysis on Apple, Inc. going back over time to see how the trends have been going with the individual components over time. Even more insightful would be to perform the analysis on the other competitors in Apple, Inc.’s industry to see how they stack up relative to Apple as well as how their component ratios have been trending over time. Let me know how that goes!
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Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
does apple finance
Are the last chapters of the iPhone saga unfolding? Not by any stretch of imagination, if you ask the Apple faithful. Definitely starting, if you ask the Android challengers.
The world and word war between Android and Apple just keeps escalating to ever greater heights, and has been the most engrossing story in business and software market for quite a number of quarters now. Let’s not even talk courtroom battles and intellectual property clashes here. Very few technologies are completely new. Most owe a debt of gratitude to forebears who laid the foundation for all the awesomeness we carry around in our bags and pockets. Let’s just talk about sales.
The release of iPhone 6 last September 2014 put the focus once more on the Apple supply chain. I pointed out in a recent article tiny “cracks” in the Apple’s Chinese supply chain, notably the introduction of robotics to cut production costs. Will these machines become more engaged in the future and displace Chinese workers, too?
Clearly, Apple has never been as popular as it was in the 2nd quarter of 2013. In the Q3 earnings call, Apple reported thanks to their highly efficient strategies as much as 31.2 million iPhones were sold in that quarter. In fact, 34 million units of iPhone 5 were sold in the first 100 days. This was a quarterly record for Apple. Contrast this with 26 million iPhones sold last year. The company’s flagship product still has firm believers worldwide. That’s not the whole story, however, because incredible as it may seem iPhone 5 sales figures in the last three quarters were lower than what Wall Street expected causing massive fluctuations in the value of Apple’s shares in the stock market.
From the left flank, it looks like the Android charge led by Samsung is gaining ground. In 2012, Apple lost its firm grip on the smartphone market and Android manufacturers were emboldened to match Apple’s products spec for spec and price point for price point. Apple still leads, but not by miles. By the end of July 2013, Android phones have 65% of all smartphone sales in the nine influential smartphone markets in the world (UK, Germany, France, Italy, Spain, USA, Australia, China, Mexico), although as a single model, iPhone still has the biggest slice of the pie – 26.3%.
In the aftermath of Apple’s double whammy release of the premium iPhone 5s and the more price-friendly iPhone 5c, the excitement over has skyrocketed to even greater heights. What fortune awaits the radical plastic-enclosed iPhone 5c? Is Apple running scared or is it just plain smart? Two can play the game, after all. If Android manufacturers are leveling up to Apple’s premium space, why can’t Apple level down to Android’s budget territory? It turns out that the iPhone 5c is not so cheaply priced, after all. It’s still a premium device targeted solidly at the mini versions of the flagship devices of Android rivals Samsung, HTC and Sony.
Fact is, Apple gets even more aggressive than usual. Weeks before the new iPhones were officially released, it implemented a trade-in program that will take hundreds of dollars off the price of the new handset if the customer turns in an older model in perfect working condition.
With sales of 9 million smartphones (combined for the 5s and 5c) reported on just the opening weekend, it looks like Apple has another winner in its hands and safely through with flying colors for the next four quarters, at the very least.
In this infographic we trace a sruprising report on how and where iPhone is made, what’s its supply and manufacturing chain and info on how much of iPhone is actually US-manufactured. We’re providing snippets of information on just who is making the parts that go into the two new iPhones, and where, exactly, these parts are made. Did you know, that the much-touted fingerprint sensor was imagined in Florida, but manufactured in Asia by Taiwanese giant TMSC? How about the M7 motion co-processor? Did you know that it’s the brainchild of NXP, a company in the Netherlands, which has fabrication facilities in Taiwan, Thailand, Malaysia, Singapore and the Philippines?
Still, reports are coming in that US companies involved in the Apple supply chain are beefing up their US production facilities and many of the components that go into the iPhone are actually made Stateside and shipped to China for assembly.
What does the rest of the world contribute to the making of the iPhone? Let’s find out!
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