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Does Keurig Green Mountain's $1 Billion Buyback Make Sense?

By Tamara Walsh – Oct 1, 2014 at 4:30PM

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Keurig Green Mountain is spending big bucks on stock buybacks. Here's what investors need to know.

Keurig Green Mountain (GMCR.DL) is returning significant cash to shareholders these days in the form of dividends and stock repurchases. On the surface, stock buybacks create value for a company's investors by reducing the number of shares outstanding. However, there are plenty of reasons to worry when companies begin buying back shares at a breakneck pace. With Keurig Green Mountain set to spend as much as $1 billion this year on share repurchases, let's take a deeper look to determine if this is actually in the best interest of its investors.

Going for broke
American companies have purchased more than $500 billion of their own shares in the past year, according to The Economist. That is an exorbitant amount of stock acquisitions, and in certain cases it can signal trouble. Some companies, for example, use share buybacks to artificially inflate earnings per share, thereby making the underlying business appear healthier than it actually is. To determine whether a company is using share repurchases responsibly, investors should keep a close watch on how management is paying for its buybacks. A company that borrows excessive amounts of money to fund these repurchases will likely feel the bite down the road.

Keurig Green Mountain has returned roughly $1.1 billion in cash to shareholders so far this year through dividends and buybacks. The specialty coffee company funded these investments through a combination of cash from operations and debt. It had $236 million in long-term debt on its books as of September 2013. However, that debt level looks manageable given the company's strong balance sheet, which boasts $260 million in cash and cash equivalents and $924 million of working capital.

Source: The Motley Fool.

The stock also has a favorable debt-to-total-capital ratio of 7.38%. Moreover, Keurig Green Mountain's ability to generate loads of cash makes its buybacks reasonable at this level. The company knows how to turn a profit, with an operating margin of 19.65% -- nearly double the industry average.

Keurig Green Mountain's quarterly dividend, meanwhile, stands at $0.25 per share. While this is nice for income investors, the stock's dividend yield of .77% is well below the S&P 500's average at 2.27% today. Nevertheless, its payout ratio of 13% means the company should have no problem funding the dividend for years to come.

Together, these numbers indicate that the company's $1 billion stock buyback is reasonable.

Keurig Green Mountain also continues to invest in its business, directing $57 million to research and development in fiscal 2013. This is important for long-term investors who want to be sure management is not scrimping on the business in order to reward shareholders.

At the end of the third quarter, Keurig Green Mountain CFO Frances Rathke said, "We're very pleased to be in a position to return significant cash to shareholders through both dividends and meaningful share repurchases while at the same time investing in our robust innovation pipeline." After digging into the company's financials, it is clear Keurig Green Mountain is responsibly rewarding shareholders today, while also investing in its future.

Tamara Rutter has no position in any stocks mentioned. The Motley Fool recommends Keurig Green Mountain. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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