How Safe Are Apple and Its Dividend?

While technology has been a great sector for world-beating gains, it's also one that comes with a lot of potential volatility and disruption. Still, there are several technology blue chips that offer both upside from technological breakthroughs, as well as relative safety and steady, increasing dividends.

Apple (NASDAQ: AAPL) has been one of the anointed tech blue chips to emerge in recent years, as its massive success with the iPhone emboldened the company to begin returning cash to shareholders in the form of share repurchases and dividends starting in 2012. The company's healthy cash flows and strong brand even lured Warren Buffett to make a large investment in Apple starting in late 2016.

However, recent trade tensions with China have put the spotlight on these large tech names, especially Apple. Not only does China represent close to 20% of Apple's revenue, but Apple also has a large part of its manufacturing operations in greater China. Does the potential for trade war escalation imperil Apple's dividend in any way?

Apple's current dividend and policy

Apple just raised its quarterly dividend during its second-quarter earnings release on April 30 to $0.77 per share, good for a 5% increase. While the increase is welcome, many had thought the iPhone giant may raise the payout by an even greater amount. After all, Apple's dividend yield currently stands at just 1.6%, and the payout ratio based on trailing-12-month earnings per share is just 26%.

Apple could certainly have afforded to pay more than just a quarter of its net income; the company is not only generating lots of cash but also has an extra $125 billion in net cash sitting on its balance sheet. Furthermore, Apple's share repurchases over the past year have reduced diluted shares outstanding by 7.2%. That means Apple may even wind up paying out less total cash for dividends this year than it did last year, even if the dividend per share goes up.

While the tepid dividend increase could signal an even greater appetite for larger buybacks or a large acquisition, it could also signal caution on management's part. But how bad could things really get?

China revenue impact

Over the past six months, including the large holiday quarter and seasonally low March quarter, Apple generated about 16.4% of its sales from Greater China. That's down rather sharply from the 20.7% of sales in the prior-year period. The decrease has been due to a slowdown in the Chinese economy that started about a year ago, but it's been exacerbated by the recent U.S.-China trade negotiations.

The worst case would of course be a ban on Apple products throughout China. Given that Apple is still a much-loved brand and the company employs millions of Chinese developers and manufacturing workers, I don't think that will happen. But if it does, what would the effect be?

Making the assumption that China has the same mix of Apple products as the rest of the world, should gross profit decline 16.4%, while keeping all operating expenses flat, Apple's pre-tax income would have fallen to $28.9 billion over the past six months, down from $37.7 billion. Net income would fall from $31.5 billion to $24.1 billion, and EPS would fall from $6.66 to $5.09.

In 2018, Apple generated 56% of EPS from its first two quarters, so the above adjustments would annualize to about $9.13, which still handily covers Apple's $3.08 upcoming annual dividend, and leaves plenty for share repurchases or acquisitions.

However, this is really a worst-case scenario. Greater China sales for Apple also include Taiwan, which would probably not ban the iPhone, and should Apple lose China sales, the company would probably be able to cut some operating costs, including all marketing in China, and perhaps some research efforts there as well.

So, based on China sales alone, Apple's dividend appears in no danger.

Supply chain blues?

The other main concern regarding Apple is its supply chain. The company depends on Foxconn (NASDAQOTH: FXCNF) for the assembly of the iPhone. Foxconn is a Taiwanese company, but most of its assembly operations for Apple are in its China location. In its annual report, Apple states: "A significant concentration of this manufacturing is currently performed by a small number of outsourcing partners, often in single locations. The Company has also outsourced much of its transportation and logistics management."

Much has been made of Apple's supply chain in China. However, on June 11 Foxconn held a rare investor meeting, during which it stated, "We are totally capable of dealing with Apple's needs to move production lines if they have any." Foxconn has manufacturing facilities not only in China, but also in Brazil, the Czech Republic, Japan, Mexico, Vietnam, and Indonesia. While the move may be a bit cumbersome and expensive, it's highly unlikely that Apple wouldn't be able to produce iPhones even in a worst-case scenario.

Dividend growth investors need not worry

Apple's results were already down year over year as iPhone sales have lagged in late 2018 and early 2019. Even with the diminished results, Apple's dividend is well covered, and it should be even in a worst-case scenario with regards to China. Investors should stay the course, and those without a position may consider taking a position on the back of trade war fears.

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Billy Duberstein owns shares of Apple and has the following options: short June $145 puts on Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.