What Does 3M Do With Its Free Cash?

Many companies talk about how they enhance shareholder value by returning cash through dividends or stock buybacks, but investors shouldn't just take the company's word for it.

In this series, we'll investigate how companies spent free cash flow over the past five years. By doing so, we hope to gain insight into whether the company's management might be good stewards of shareholder capital.

Today, we'll take a look at industrial conglomerate 3M (NYSE: MMM  ) .

How does it spend free cash?
First, let's have a look at how much free cash flow the company has generated in each of the past five years and how much of that has gone to dividends and buybacks.

 

2010

2009

2008

2007

2006

Buybacks $854 $17 $1,631 $3,239 $2,351
Dividends $1,500 $1,431 $1,398 $1,380 $1,376
Total Paid $2,354 $1,448 $3,029 $4,619 $3,727
Free Cash Flow $3,912 $3,809 $2,955 $3,055 $3,428

Source: Capital IQ as of July 12, 2011.
Figures in millions.
 Free cash flow = net income depreciation-capital expenditures-change in noncash working capital.

3M has one of the more enviable dividend track records in the S&P 500, having raised its payout each year for 53 consecutive years, a streak that began during the Eisenhower administration.

Cumulatively over this period, 3M bought back more than $8 billion of its shares while paying out nearly $7.1 billion in dividends, so despite the long dividend track record, it's unclear as to whether 3M prefers to return shareholder cash via buybacks or dividends.

Is the dividend covered?
Next, let's see how much of the company's free cash flow has gone to dividends.

 

2010

2009

2008

2007

2006

FCF Payout Ratio 38% 38% 47% 45% 40%

Source: Capital IQ, a division of Standard & Poor's.

3M has been incredibly consistent over this five-year period, paying out between 38% and 47% of free cash flow each year as dividends. As such, 3M's dividend (2.3% yield) today appears well-covered by free cash flow.

Is it a good investor?
Companies are notoriously bad investors in their own stock. Consider that in 2007, when the market was hitting record highs, S&P 500 companies bought back a record $589 billion, versus $246 billion in cash dividends. In 2009, when the market was around its nadir, buybacks hit record lows.

Is 3M an exception?

Source: Capital IQ, a division of Standard & Poor's.

Judging by this chart, it seems fair to question 3M's buyback discipline.

With the benefit of hindsight, its buyback pattern seems to roughly follow its share price -- when the stock has been up, they've tended to buy back stock; when it's been down they've held off.

While I wouldn't necessarily consider this a red flag, I'm slightly skeptical of management's decision to spend $7 billion on buybacks this year following a good run in the stock price. According to Capital IQ, 3M's five-year average price-to-earnings ratio is 15.3, while its current trailing P/E is 16.5, so it's hard to argue the shares are in value territory today -- at least enough to justify such a massive buyback.

Competitors
How does 3M's use of free cash flow stack up against some of its major competitors over the past four quarters?

Company

Free Cash Flow

Share Buybacks

Dividends

3M $3,396 $1,514 $1,518
Emerson Electric (NYSE: EMR  ) $2,242 $252 $1,027
Danaher (NYSE: DHR  ) $1,770 $0 $52
Tyco International (NYSE: TYC  ) $2,619 $1,900 $426

Source: Capital IQ, a division of Standard & Poor's.
All figures in millions as based on trailing-12-month data.

Foolish bottom line
3M has been an extremely reliable dividend payer for more than half a century, carries a sterling balance sheet, and consistently generates a ton of free cash flow. Its buyback strategy and discipline are a concern, though, and if I were a shareholder it's a question I would try to get management to answer.

Todd Wenning is the advisor of Motley Fool (UK) Dividend Edge. You can follow him on Twitter. He does not own shares of any company mentioned. Motley Fool newsletter services have recommended buying shares of 3M and Emerson Electric. Try any of our Foolish newsletter services free for 30 days.

We Fools don't 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.


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