Consumer staples giant Kimberly Clark (NYSE:KMB) generates a lot of free cash flow. The company uses this cash flow to reward shareholders in multiple ways, once its capital expenditure needs are satisfied. The two ways the company returns cash to shareholders are its dividend and its share repurchase program.
When a company maintains a billion-dollar buyback program, it's reasonable for shareholders to question whether management is properly allocating capital. After all, there are many other potential uses for that money that could better create value for shareholders, such as capital expenditures, to spur new product innovation, or a hefty dividend to satisfy income investors.
But Kimberly Clark's share buyback program is right on the money because it's allocating enough capital to each of those other initiatives. Kimberly Clark already pays a hefty dividend, so there's no reason for income investors to feel short-changed. And, the industry that Kimberly Clark operates in, which is consumer staples, isn't one that requires a great deal of capital investment to grow. That's why Kimberly Clark's share buybacks are an effective use of capital.
Enough cash to accomplish all necessary initiatives
Over the first half of the year, Kimberly Clark generated $840 million in free cash flow. That was up 22% from the same period the year before. As mentioned previously, Kimberly Clark is in the enviable position of generating enough free cash flow to reward shareholders in multiple ways. Through the first six months of 2014, the company spent $917 million on buying back its own stock and paid $627 million in dividends.
One reason why Kimberly Clark's buybacks are a good use of capital is because the company is not short-changing other potential uses. First, Kimberly Clark already rewards shareholders with a compelling dividend. Kimberly Clark yields 3% right now, which beats the approximately 2% yield of the S&P 500 Index. In February, Kimberly Clark increased its quarterly dividend by 3.7%. This marked the 42nd consecutive year with a dividend increase. Because the company already pays an above-average dividend yield, there's no immediate need to increase it above its current rate of dividend growth.
In addition, Kimberly Clark operates in the consumer staples industry. Its major products include Kleenex, diapers, paper towels, and toilet papers. Kimberly Clark is not a capital-intensive business. As a result, it doesn't need to allocate an overwhelming portion of its cash flow toward capital expenditures. Whereas in other industries where constant innovation is key to survival, like technology, paper towels and diapers are nearly the same as they were decades ago. Kimberly Clark actually trimmed capital spending through the first six months of the year, by 11%, versus the same period last year. That helped produce a significant portion of its free cash flow growth in this period.
Spin-off to allow even greater repurchases
Several months ago, Kimberly Clark advised investors it would pursue a spin-off of its health care business Halyard Health. This is nearing completion, and is expected to go into effect on Oct. 31. Recently, Kimberly Clark announced that it will receive a sizable cash payment from Halyard Health as part of the spin-off. Because of this, Kimberly Clark is increasing its 2014 share repurchase target to $2 billion, a huge increase from its previous buyback expectation which called for between $1.3 billion-$1.5 billion. This will result in even greater value creation through the increased buyback plan.
The bottom line
Kimberly Clark rewards its shareholders through a competitive dividend and a large share buyback plan. While in certain cases, there is cause for concern that perhaps a company is spending too much money on share buybacks and not enough on other shareholder cash returns or capital investments, that doesn't appear to be the case here.
In addition, Kimberly Clark does not operate a capital-intensive business. It's actually in the process of cutting capital spending, with the stated goal of freeing up more cash to return to shareholders. Kimberly Clark's planned spin-off of its health care unit will accelerate this process. The bottom line is that shareholders should thoroughly approve of Kimberly Clark's buybacks in addition to a high dividend with a long track record of dividend growth.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Kimberly Clark. 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.