The best companies are expert at constantly innovating and reinventing themselves in response to an ever-changing world. When old tactics aren't going to cut the mustard in the future, they don't balk; they evolve.
And that's exactly what 3M (MMM 0.58%) intends to do in its ambitious bid to restructure its business into a smaller and more tightly focused entity. If things go as planned, shareholders will be able to look forward to more decades of reliable earnings and dividend growth.
But nothing is guaranteed, so here's how to start thinking about what to do with your shares.
Twin spinoffs loom this year and next
As announced on July 26, 3M is planning to spin off its healthcare division, which brought in around $8.6 billion out of the company's $26.8 billion in revenue during 2021. The transaction is expected to close by the end of 2023, and it'll help to streamline its operations and pave the way for further profitable growth.
3M is also in the process of spinning off its food safety unit, but the transaction will close much sooner, on Sept. 1. But food safety services were only worth $400 million in 2021, so it isn't as significant of a change for shareholders wondering what's in the future.
The healthcare spinoff will focus on filtration products for biomedical applications, healthcare software, wound care, and oral care. In contrast, 3M itself will double down on its existing portfolio of industrial safety products, including consumer goods like tape, and its transportation and electronics segment. Eventually, that increased focus should lead to higher margins and perhaps better market penetration, too. Though the details of the transaction are still in flux, current shareholders will almost certainly be given the option of having a portion of their 3M shares convert into shares of the new entity -- and that's where things just might get even better.
Per management, capital allocation priorities, like the proportion of capital intended for dividend payments, aren't expected to change before the transaction is complete sometime next year. With more than 60 years of consistently hiking its dividend, the company is a Dividend King, but it's unclear whether the spinoff will be interested in continuing to maintain membership in the royal club.
In fact, management is already hinting that the two businesses will be attractive to different groups of investors, which could imply that the healthcare entity will be focused more on growth than on distributions.
If that's the case after the transaction, investors could get the benefit of faster growth in both entities as the streamlining should improve the performance of the original 3M after a few potentially challenging quarters. It might also be an opportunity for shareholders to sell their shares of the new business at a premium to reinvest in the original 3M, assuming there's an option to do so as there will be with the food safety spinoff.
It may not all be smooth sailing
The current expectations for the new healthcare company are that it'll have an earnings before interest, taxes, depreciation, and amortization (EBITDA) margin of around 31%. That sounds just fine, but investors should recognize that the new healthcare entity could be a bit risker than their current 3M holding. Right now, 3M has $17.2 billion in debt and capital lease obligations, and the new healthcare entity will be taking on a hearty helping of that load when it separates.
As of its second-quarter update, 3M's quarterly free cash flow (FCF) is down by 41% year over year, and that might be a problem if the trend continues through the spinoff. Alternatively, the transaction could help to abate the downtrend if pushing the healthcare segment's growth is what's costing too much. 3M is pausing its share repurchasing program for the moment, too, so this issue is key for future returns.
It's probable that 3M will be able to deleverage and improve its performance enough to continue paying its dividend through 2023 and beyond. Nonetheless, this will be a big change for a relatively stable company, and there could be a few bumps along the way. Healthcare is its fastest-growing and most profitable segment, so there may be some short-term margin compression, not to mention some slowing of growth before new investments in the remaining segments start to yield earnings.
3M's stock price could get a bit battered as the company adapts -- but that'll be an opportunity for investors with a long time horizon to pick up a few shares. Just try to keep in mind that the new 3M might take a while to find its footing and reach the same level of financial stability that it's known for, and also that it probably won't outperform the market anytime soon.
