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2 Dividend Stocks Ideal for Retirees

By Lee Samaha - Aug 31, 2020 at 8:53AM

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3M and Pentair are generating significant cash flows to fund payouts to investors.

Industrial conglomerate 3M (MMM 1.72%) and water-treatment technology company Pentair (PNR 2.10%) both have solid dividends, good growth prospects, and attractive valuations in relation to their risk profile. All of which makes them good stocks for retirees to consider. Let's take a closer look.

Dividend yield and free cash flow

The case for both stocks rests on the idea that they already pay useful dividends that are amply covered by free cash flow (FCF). In addition, they have the potential to significantly grow FCF, ultimately leading to long-term dividend increases. FCF is simply the cash that's left over from profits after the capital needed to run the business is stripped out alongside capital expenditures. 

A man standing in front of rising cash.

Image source: Getty Images.

3M has a dividend yield of around 3.6%, with Pentair around 1.6%. As you can see below, their dividends are well covered by FCF. 3M is currently using 57% of its FCF on its dividend, while Pentair is using just 27%. Clearly, both stocks have room to grow their payouts. 

MMM Free Cash Flow Per Share Chart

Data by YCharts.

3M

You can think of 3M as the value play of the two options. The company has seemingly lost its way (and its premium rating in the industrial sector) in the last few years after consistently failing to meet its own guidance and disappointing with the performance of its consumer and healthcare businesses. With its least-cyclical businesses in need of improvement, the company was ill-prepared for a 2020 that saw the industrial economy start off on a weak note only to slump dramatically due to the COVID-19 pandemic.

The pandemic has hit 3M hard. Its exposure to the automotive, aerospace, and oil and gas markets has hurt the company badly in 2020, and there are still questions around its margin performance

That said, CEO Mike Roman is actively restructuring the business (two major healthcare acquisitions, totaling $7.7 billion, were made in 2019), and a drug delivery business was sold for $650 million in 2020. Meanwhile, management continues to restructure how the company is run.

There's still a lot work to be done, but as you can see below, 3M looks like a good value on a price-to-FCF basis. Furthermore, good FCF ensures Roman has the financial firepower to engineer an improvement, and when the automotive and general industrial economies improve, 3M will see volume improvement. Meanwhile, investors will earn a very useful dividend.

MMM Price to Free Cash Flow Chart

Data by YCharts.

Pentair

"It's different this time." While those words are often the most inaccurate ones ever written about investing, this author will stick his neck out and stand by them "this time." Simply put, when a normal recession occurs, there is usually some sort of graduation into it: The debate is usually over whether the start of the downturn is a blip or the start of a trend. As such, retailers and distributors often start reducing inventory before the full force of the downturn hurts.

But due to the sudden and abrupt nature of the coronavirus lockdown measures, it's likely that retailers and distributors would have had a lot of inventory on hand before the sudden slump happened. As such, there's likely to be a lag between sales growth at distributors like Pool Corporation (NASDAQ: POOL), which is responsible for 15% of Pentair's sales, and sales growth at a supplier like Pentair.

A residential swimming pool.

Image source: Getty Images.

The good news is that Pool's sales have been on a tear in 2020 with a 14% increase in the second quarter, as stay-at-home measures have spurred spending on residential pools. At some point, Pool and other distributors will surely replenish their inventory -- good news for Pentair down the line. Meanwhile, a pickup in industrial activity will help Pentair's commercial- and industrial-based sales in 2021.

All told, Pentair's sales, earnings, and FCF look set to bounce strongly in 2021, and the stock's valuation is attractive for a company exposed to long-term demand for water treatment.

Are they stocks to buy?

All told, both stocks are worth picking up. 3M is the value option with a very attractive yield in the current environment of low interest rates. Meanwhile, Pentair has plenty of potential to grow its dividend in the near and long term. Those qualities should suit investors looking for stocks that create a stream of dividends for their retirement portfolios. 

Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends 3M and Pool. The Motley Fool has a disclosure policy.

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Stocks Mentioned

3M Company Stock Quote
3M Company
MMM
$152.24 (1.72%) $2.58
Pentair plc Stock Quote
Pentair plc
PNR
$50.69 (2.10%) $1.04

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