Mondelez International (NASDAQ:MDLZ) knows how to reward shareholders. In the first half of the year, the packaged foods giant repurchased as much as $900 million of its own stock at an average price of around $35 per share. It also increased its quarterly dividend by 7% to $0.15 per share. Returning capital to investors through share buybacks can create shareholder value. However, there are plenty of reasons to worry when companies begin buying back shares at a breakneck pace. With Mondelez on track to spend as much as $2 billion on buybacks alone this year, let's take a deeper look to uncover if this is actually in the best interest of its shareholders.
Burning through cash
American companies have purchased more than $500 billion of their own shares in the past year, according to the Economist. On the surface, this seems like a good thing for investors because share buybacks create value by reducing the number of shares outstanding. However, stock buybacks can also artificially inflate a company's earnings-per-share, thereby making the underlying business appear healthier than it actually is. Investors should also keep a close watch of how the company is paying for their buybacks. If said company is over borrowing to pay for these repurchases it will likely come back to bite them down the road.
Mondelez has only paid a dividend since 2009. This makes it less reliable than other consumer goods companies such as Procter & Gamble, which has paid a dividend every year for the past 124 years. Nevertheless, past performance isn't everything. Investors should also pay close attention to how the company is funding its dividend payouts and share repurchases. Mondelez, for example, is funding its buybacks through a combination of available cash and short-term debt.
Additionally, a portion of these buybacks will be purchased with cash from the resolution of Mondelez's snafu with coffee giant Starbucks (NASDAQ:SBUX). Mondelez got a nice capital boost last year when Starbucks was forced to pay the snack giant $2.8 billion for the early termination of a distribution agreement it had with pre-split Kraft Foods (Mondelez was spun off of Kraft Foods in 2012).
Mondelez has said it will spend this windfall of cash on share buybacks. In 2013, Mondelez's board approved a $7.7 billion repurchase plan that will be executed through 2016. The company is now on track to repurchase as much as $2 billion of its shares this year. This seems more than reasonable given the $2.8 billion in cash from the Starbucks arbitration.
Yet, while Mondelez does a good job of generating cash from operations, it is also spending that cash at an alarming rate. The company generated $2.3 billion in free cash flow in fiscal 2013, but it spent $2.7 billion over that period on share buybacks. This isn't a problem now because Mondelez currently has plenty of cash on its balance sheet to justify repurchases.
However, it would be nice to see Mondelez invest more in its business. Consider this, Mondelez invested just $471 million in research and development last year. That is spare change compared to the $3 billion it spent on dividends and share buybacks that year. Moreover, with a dividend yield of just 1.6% there are better stocks available to investors today that are rewarding shareholders through dividends and buybacks but with much more cash generation to back them up.
Tamara Rutter owns shares of Mondelez International and Starbucks. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. 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.