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Business Overview
$MMM is a large diversified manufacturer and technology company. With over 60,000 products in more than 200 countries, it is not surprising that thencompany is among the leading manufacturers in many of the markets it serves.
The company currently operates in four business segments; Safety and Industrial; Transportation and Electronics; Health Care and Consumer which is detailed from page 4 of the 2020 10-K
- The Safety & Industrial division produces tapes, abrasives, adhesives and supply chain management software. It also manufactures PPE and security products.
- The Transportation and electronics supply Advanced materials, Commercial solutions, display materials and systems and safety systems
- The healthcare segment supplies food safety, medical and oral care solutions
- The Consumer division supplies Home care, Home improvement and stationary and office equipment.
3M is a dividend King, the company has an impressive 60-year record for increasing dividends. But, of course, a 60-year streak is no easy feat, and such a record deserves attention for any dividend growth investor.
Income Statement
When starting to analyse a companies’ financial position, I start with the income statement. I generally look through 10 years of statements where I am interested in the average growth of Revenue, net Income, and Earnings per share. Basically, I’m looking to see if there is a demand for a company’s products and if they generate profit after costs and taxes. I also want to see that their bottom line and their EPS is growing above the rate of dividend increases.
Revenue Growth
3Ms revenue has grown from $29,611 million in 2011 to $35,355 million in 2021 for a CAGR of 1.79%. In fact, it was the 9.8% increase in revenue in 2021 compared to 2020 that has contributed to the compound annual growth rate exceeding 1%.In the years preceding 2021 the revenue has been pretty flat. During the same time, however, the company’s gross margin has increased from 47% to 55% which means the company is retaining 8% more of its revenue in 2021 than in 2011.
Operating Income
Operating Income or EBIT (Earnings before Interest and Taxes) is a good measure of the company’s profitability. It is particularly useful if you want to compare companies in the same industries with different tax rates. Again 3M have been pretty consistent here with an operating income of average operating profit of $7 billion over the last 10 year. However Operating margin has been dropping since 2015 where it was 23.4% to 20.8% in 2021.
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On Page 17 of the income statement the company mention the decrease
“3M’s operating income margins decreased 1.5 percentage points year-on-year for the year ending December 31, 2021. Factoring out the impact on operating income of special items as described in the Certain amounts adjusted for special items “
On page 20 you will find information in relation to litigation charges, pre tax charges and divestiture related costs along with the operating income for each segment.
Net Income
Net income is often referred to as the bottom line as it appears at the very end of an income statement. It is the amount a company makes after deducting COGS, expenses, depreciation, interest and taxes.
Over the last 10 years Net Income has grown at a 3.29% CAGR while their Net Income Margin has increased from 14.5% to 16.7%. According to Ready Ratios the industry average profit margin is -6.4% so 3M is doing pretty ok on this front.
GAAP EPS has grown at 5.44%. EPs has grown at a faster rate with help for share buybacks as they have decreased from 709 million shares in 2011 to 572 million shares in 2021.
Balance Sheet
The balance sheet offers investors a quick snapshot of the financial health of a company. Myself and European DGI have discussed how we analyse the balance sheet in one of our earlier episodes of dividend talk
Of course if you want to learn fro the Harvard business school, this is a pretty good primer for beginners. https://online.hbs.edu/blog/post/how-to-prepare-a-balance-sheet
Assets and Goodwill
3M’s assets have grown from $31.6 Billion in 2011 to $47 Billion in 2021 however I like to check what percentage of assets are listed as goodwill.
When a company acquires another company and pays a price that is higher than the tangible book value of that company, they’ll incur a loss on their balance sheet and income statement. To avoid this problem, the acquiring company can put the difference between the purchase price and tangible book value of the acquired company on their balance sheet as “goodwill”. Whenever you see an increased amount of goodwill over a number of years you can assume the company can be buying other businesses. depending on the business they bought this can be seen as a good thing.
In 2019 3M completed the acquisition of the healthcare technology business M*Modal for $0.7 billion of cash, net of cash acquired, and assumption of $0.3 billion of M*Modal’s debt. In the same year the company also completed the acquisition of all of the ownership interests of Acelity Inc. and its KCI subsidiaries. Both purchases added $3,469 million in goodwill to the balance sheet.
3M’s Debt
Debt is an important factor in the capital structure of a company, and can help it often aid the company growth. Debt usually has a relatively lower financing cost than equity, which makes it an attractive option for executives. However, Interest-payment obligations can impact the cash-flow of the company and ultimately the ability to pay its dividend.
3M debt levels are at $17.3b in december 2021, down from $18.8 billion, one year before. It might seem like a lot, but it is not so bad since 3M has a market capitalization of $91.97b and can raise capital with a $3 billion credit facility to strengthen its balance sheet if needed. Whether or not it can manage its debt without dilution is another matter.
We calculate a company’s long term debt divided by its EBITDA (earnings before interest, tax, depreciation, and amortization) to find its debt relative to its earnings. 3M has a net debt to EBITDA of 1.85, which is not actually too bad.
Debt/Equity
The debt to equity ratio is a standard financial leverage ratio representing the debt and equity used to finance a company’s assets. A high percentage of debt concerning equity is usually a red flag for dividend growth investors.
The D/E ratio is calculated by dividing a firm’s total liabilities by total shareholders’ equity.
3M has a high debt to equity ratio of 2.11, which suggests the company is highly leveraged.
Interest Coverage
Interest coverage is probably one of the most important metrics that a dividend growth investor can use when checking MMM stock dividend safety. The more debt a company has, the greater the amount of interest they have to pay. In a low-interest environment, this may not burden the company’s cash flow, but this could change as interest rates increase. The more cash a company has to pay out on debt, the less it will have to pay a dividend.
The interest coverage ratio calculation is EBIT/Interest Expense. Interest coverage is essentially the number of times a company can pay its interest with its earnings before interest and taxes. A number above three is desirable for most companies.
EBIT easily covers interest expenses by 12.5 times the size.
Long Term Debt
3Ms balance sheet could be a little stronger but admittedly there seems to be little to be concerned about in terms of the company managing its debt load. Its also worth checking the maturity of long term debt which also look to be be more than manageable by 3M
Dividends
3M’s dividend growth rate has exceeded the average dividend growth rate of the S&P 500 for the last 15 years. Investors usually use the S&P 500 as a benchmark to beat over the long term, so investing in companies with a history of outperforming the index is sometimes preferred. The last increase of 0.68% comes off the back of a paltry 2% increase last year.
I am not surprised to see this based on the earnings and revenue growth as discussed above. A company cannot continue to increase dividends at a faster pace than earnings and free cash flow for a sustained period. While this was the lowest increase the company has made since 1990, we have seen the company go through periods where the dividend growth is typically lower than average but when analysing the Dividend growth rate for 15, 10, 5, 3 and TTM the trend is quite clearly downwards.
Earnings payout ratio
The earnings payout ratio is calculated as Dividends Per Share / Earnings Per Share and determines what percentage of the company’s EPS funds the dividend. Therefore, a combination of revenue and earnings growth and a low payout ratio is usually a good sign for a sustainably increasing dividend.
In 2021, the Payout Ratio was 58.5% which is below our 70% safety net. The 5-year average is also below 60%. Over the same five-year period, earnings have grown at a compound annual growth rate of 4.4%.
The payout ratio increased as the dividend growth rate outpaced the earnings growth rate.
Usually over an extended timeframe, the dividend growth rate will reduce to match earnings growth, which we saw with 3M in 2020 and 2021 when the company only increased the dividend by 2% and 0.68%, considerably lower than the five-year average of 5.92%.
Free Cash Flow payout ratio
While earnings per share is a good indicator, there are ways that companies can manipulate these figures. A better indicator of some investors in free cash flow. The Free cash flow payout ratio is calculated as Total Dividends / Free Cash Flow and tells you what percentage of the company’s free cash flow is being used to fund the dividend.
In 2020 the payout ratio was 58.45%, and the five-year average is 58.9%. In addition, Free cash flow is growing slowly, with a five-year average of 2.22%. Worryingly this is below the five-year dividend growth rate of 5.92%
My Take
3M score a very respectable 79/100 using my screening process and have a dividend safety rating of 78/100. Financially the company look sound and the management appear to be managing the debt load extremely well. Over all I would say that this is a well managed and reliable company with an impressive dividend history. The company offers an excellent starting yield of 3.75% which is above the historical average of 2.55%. However my main concerns are
Lack of growth
The companies top and bottom line have ben relatively flat over the last 10 years. It is a little bit expected for a mature company of this size. I want to see dividends increasing every year and if dividend growth is outpacing Revenue, Earnings and FCF for a sustained period than it is inevitable that the dividend growth will slow down. I don’t anticipate 3M cutting the dividend anytime soon but I would prefer that the dividend raises sit above 5%. 2% and 0.68% just don’t cut it and don’t help me get near my goals quick enough.
Ongoing Litigation
I also have only briefly mentioned litigation in the operating income section of this review, however there is a large elephant in the room. 3M are embroiled in a potentially damaging litigation in relation to its earplugs. It is estimated up to 300,000 lawsuits will be filed in total. They recently lost $110 million in the Slogan/Wayman bellweather trial. This smells like Bayer all over again where the company are inheriting costly mistakes from a company they acquired. In this case 3M purchased Aearo Technologies. I would hope that 3M do a better job than Bayer with dealing with the litigation but I have a feeling it could drag on for a couple of years yet.
Inflation
Higher inflation rates will always impact companies such as 3M as rising costs can affect the companies overall profits.
Recommendations
Simply Investing Report review – For investors who might like to have all the research done for them
Sure Dividend – Ben and his team help individual investors build high-quality dividend growth portfolios for the long run and offer a lot of excellent content for free. I write company review articles on Sure Dividend each Quarter.
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This dividend stock has been on my watchlist for a long time now. Although it is slowing I might just take a small position.