Smiling, she dried his hair with a towel.

Literal

Smiling [while-ながら] she [topic-は] his hair [object-を] towel [by-で] wiping [for-him-てあげた].

微笑みながら uses ながら for simultaneous action. タオルで拭いてあげた uses てあげる (benefactive — doing for his benefit) + instrumental で. A warm, caring scene.