3M: A dividend king in headwinds.
Opdateret: 7. aug.
3M is a dividend king that has raised its dividend for 65 consecutive years, meaning that only seven other companies have raised their dividend for more consecutive years. 3M is facing different challenges that have resulted in the share price plummeting over the last few years. Thus, 3M shares are currently trading at the highest dividend yield in over a decade.Does it mean that now is the time to buy 3M shares? It is something I will investigate in this analysis..
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares in 3M. If you would like to see the stocks in my portfolio or copy my portfolio, you can do so on eToro. You can find instructions on how to do this here. I don't own any stocks in any competitors of 3M either. Thus, I have no personal stake in 3M. As always, I will keep this analysis unbiased. If you want to purchase shares or fractional shares of 3M, you can do so through eToro.
3M was founded in Minnesota, USA in 1902 and was called Minnesota Mining and Manufacturing Company until 2002 when they changed their name to 3M Company. The company produces more than 60,000 products, including adhesives, abrasives, laminates, passive fire protection, personal protective equipment, window films, paint protection films, dental and orthodontic products, electrical and electronic connecting and insulating materials, medical products, car-careproducts, electronic circuits, healthcare software, and optical films. Their products are sold through various distribution channels, including direct sales to consumers, e-commerce platforms, traditional wholesalers, retailers, jobbers, and distributors. 3M operates in more than 70 countries and generates approximately 60% of its revenue outside of the United States. They have divided their business into four different segments: Safety & Industrial (34% of sales in 2022), Transportation & Electronics (26% of sales in 2022), Health Care (25% of sales in 2022), and Consumer (15% of sales in 2022). However, 3M will spin off their health care business in 2023, which will then be a standalone publicly traded company with 3M owning 19,9 % of the company. With more than 60,000 different products, 3M has a wide range of trademarks, patents, and trade secrets, which give it a moat. Furthermore, it is worth noting that no single patent or group of related patents is essential to the company as a whole or any of its business segments. This information is reassuring for investors.
Their CEO is Mike Roman. He joined 3M in 1988 and became the CEO in 2018. Before becoming the CEO, he held various positions at 3M, such as COO and CSO. He holds a bachelor’s degree from the University of Minnesota and a master’s degree in electrical engineering from the University of Southern California. He also serves on the board of Abbott Laboratories and President Biden’s Export Council. He has previously been ranked in the top 100 of most popular CEOs of large companies by Glassdoor. He is also known for publicly disagreeing with former President Donald Trump regarding 3M’s handling of face mask distribution during the pandemic. Mike Roman has faced his fair share of challenges since becoming CEO, including navigating a global pandemic and dealing with various litigation cases, which I will discuss further in the analysis. Thus, it may be a bit unfair to judge Mike Roman based solely on his results. However, he has faced criticism from at least one major shareholder who has suggested a need for a management overhaul. The reason for the criticism is that since Mike Roman became the CEO, 3M shareholders have lost 32%, while the S&P 500 has gained 62%. However, the question is how much responsibility Mike Roman has. Mike Roman has vast experience with the company, as he joined 3M more than 30 years ago. Some may believe that he deserves to prove himself in a period without pandemics or litigations.Nonetheless, I believe that there is a lot of uncertainty regarding management until I have seen Mike Roman deliver sustainable growth.
I believe that 3M has a strong brand moat. However, I believe that there are some uncertainties regarding the management. Now let us investigate the numbers to see, if 3M does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all the numbers being above 10% in each year. 3M has managed to deliver a ROIC above 10% every year in the last ten years. However, ROIC has been decreasing, and 3M has not managed to deliver a ROIC above 20% in the last four years. This is a departure from their performance in the period 2013 to 2018, where they achieved a ROIC above 20% in four out of six years. However, 3M has managed to increase their ROIC every year in the last four years and reached 18.3% in 2022.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actualnumbers and the percentage growth year over year. The numbers are a bit mixed, and we have experienced a decline in equity over the past few years. However, lately we have seen equity grow, and it has almost reached the level of 2019. I'm not overly concerned about equity decreasing slightly in 2022, as it has been a challenging year for most companies.
The next number to investigate is the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. Free cash flow yield is the expected free cash flow per share thata company will earn in relation to its market value per share. It is not surprising that 3M has delivered a positive free cash flow in the last ten years, and it was also expected that the pandemic year in 2020 would be their best year so far. Free cash flow has significantly decreased in a challenging 2022, and it is something you would like to see increase in 2023.Levered free cash flow margin has remained consistent, ranging from 14% to 17% over the past ten years, except for 2020 and 2022 which were outliers. Free cash flow yield is relatively high at 5.6%, which suggests that 3M is trading at a relatively cheap valuation. However, we will discuss this further in the analysis.
Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings.Doing the calculation on 3M, I can see that 3M has 2.42 years in debt earnings. It is below the 3-year requirement, so debt is not something that I worry about.
Based on my preliminary findings, I believe that 3M could be an intriguing company. However, no investment is without risk, and 3M also has its share of risks. One risk is litigation. I previously wrote about litigations, and currently, 3M is facing two litigations. 3M has been sued for polluting drinking water with PFAS. It means that 3M is facing potentiallitigation costs that could amount to $100 billion. The litigation costs will likely be much lower but still have a significant impact on 3M over an extended period of time. Furthermore, 3M will also exit their PFAS business, which is currently generating 1,3 billion in sales. 3M has also been sued by over 200,000 military service members regarding the allergic reactions caused by 3M's combat-grade earplugs, which have resulted in hearing damage. Although the financial impact on 3M is uncertain, it has already tarnished their brand.. Another risk is decreasing profit margins. Gross profit margin and operating margin have both reached a ten-year low in 2022. The margins have decreased for various reasons. One area affected is macroeconomics, where increased prices ofraw materials, logistics, and energy have resulted in a negative impact of 130 basis points on operating margins. 3M generates approximately 60% of its revenue outside the United States. Therefore, the strong U.S. dollar has also impactedmargins. Management mentioned that foreign currency translation had a negative 2,8% impact on total sales and a -30basis point impact on margins. If we continue to see high inflation and a strong dollar, it will impact 3M's future performance. Change in customer preferences. Change in customer preferences is something that 3M mentions as a risk in its annual report. They mentioned that changes in customer patterns and fluctuations in the levels of inventory maintained by customers could impact the business. It is something that we have observed throughout 2022, where 3M has maintainedhigh inventory levels. These elevated inventory levels have negatively impacted profitability, which is another factor contributing to the decline in free cash flow in 2022.
3M also has a lot of potential for growth. One growth catalyst is that 3M has implemented a restructuring program. 3M wants to reduce costs through a new restructuring program. The restructuring program is expected to free up $700-$900 million once it is completed in 2024, and it is projected to benefit the company starting from 2025 and beyond. These benefits should result in margin expansion, and management expects the margin expansion to be between 200-300 basis points on an annualized steady-state basis. Management believes that the restructuring program will enable them to exit 2023 stronger than they started and provide significant margin and cash flow improvement into the future. Focusing on high-growth markets. Management has mentioned that they want to prioritize high-growth markets moving forward. They specifically mentioned automotive electrification, personal safety, home improvement, semiconductors, and healthcare as the high-growth markets they will prioritize. Furthermore, management also wants to invest in large emerging markets that demand their material science innovation, such as climate technology, industrial automation, next-generation electronics, and sustainable packaging. These are all markets that are expected to experience significant growthin the future. The Health Care Spinoff. While 3M's healthcare business hasn't performed well lately, experiencing little organic growth and decreasing margins due to various challenges such as labor shortages in the healthcare sector, it still has the potential to benefit shareholders. Spinoffs are usually made because management feels that their divisions are not valued properly, and they may have a point. A global study conducted by consulting firm The Edge and accounting firm Deloitte examined35 global spinoffs from 2000 to 2014, involving parent companies with a market capitalization of over $250 million. They found that spinoffs generated more than ten times the average gains of the MSCI World Index during the first twelve months. It is not certain that we will see the same price action when it comes to 3M's health care business. However, if management is correct in stating that the division is not being valued properly, it should benefit shareholders in the long term.
All right, we have gone through the numbers, potential and risk regarding 3M, and now it is time for us to calculate a price for 3M. In order to calculate price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website, as I do not want to go through the whole calculation here. I chose to use an EPS of 10,18, which is from 2022. I chose an estimated future EPS growth rate of 3% (3M has delivered 5% growth in the last 5 years, but I prefer to be conservative). I also selected an estimated future PE of 6 (which is doublethe growth rate, as the historical PE for 3M has been higher). Additionally, we already have the minimum acceptable return rate at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $20,29. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy 3M at aprice of $10,15 (or lower, obviously) if we use the Margin of Safety price.
Our second way to calculate a buy price is the Ten Cap price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 5.591 The capital expenditures were 1.749. I tried to look through their annualreport to see how much of the capital expenditures were used for maintenance. I couldn't find it, so as a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 1.224 in our furthercalculations. The tax provision was 612. We have 549,245 outstanding shares. Hence, the calculation will be like this: (5.591 - 1.224 + 612) / 549,245 x 10 = $90,65 in Ten Cap price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With 3M's Free Cash Flow Per Share at 7,35 and a growth rate of 3%, if you want to recoup your purchase in 8 years, the Payback Time price is $67,32.
3M is an interesting company with a strong competitive advantage. There are some doubts regarding management, and I believe that management will need to prove themselves moving forward in order to gain trust. 3M is facing litigation, which is why the share price has plummeted over the past couple of years. I would like the PFAS litigation to be sorted out in order to gain clarity on how much the company will need to pay. I am not impressed by the decrease in 3M's margin and the way management has handled inventory, which has had an impact on free cash flow. However, if management succeeds with its restructuring program and switches its focus to growing markets, 3M could be an interesting long-term investment. You will need to trust that management will execute, though. The spinoff could be a speculative trade, as you would receive shares at a relatively low valuation considering where the 3M shares trade at now.However, the share prices of spinoffs usually drop right after the IPO, as institutions need to sell for various reasons.Thus, it may be worth waiting if you want to buy a healthcare business. Personally, I believe there are too many uncertainties regarding 3M, and I will not be buying 3M shares.
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