In past years, the conversation surrounding 3M (MMM -0.28%) stock would be based on its growth prospects, steady cash flows, 64 consecutive years of dividend raises, and its value as a source of passive income in a diversified portfolio.
Nowadays, it is impossible to mention 3M without addressing the elephant in the room -- its legal issues.
Here's a breakdown of what's plaguing the company right now, as well as the core reason not to follow the crowd and sell the stock.
To illustrate how dire the situation is, note that on Sept. 6, 3M stock reached an intraday low of $115.98 per share -- a decline of over 55% from its all-time high in early 2018. The intraday low marked the lowest price 3M shares have traded in nine years.
3M has been making headlines for the wrong reasons as of late, namely for a class action lawsuit that argues its military-grade earplugs led to hearing loss. The lawsuit could result in tens of billions of dollars in costs for 3M through its subsidiary, Aearo Technologies, which manufactures the earplugs. In late August, the U.S. District Court for Indiana (Aearo is based in Indiana) denied 3M bankruptcy protection from Aearo's debts. Put another way, 3M will now have to juggle Aearo's restructuring and the ongoing earplug lawsuits. 3M responded with an appeal.
The news followed 3M's late July announcement to spin off its healthcare business, arguing it would create long-term value for shareholders. However, the spinoff is more likely an attempt to divert assets and limit legal damages to the parent company, which is why 3M has faced opposition for the attempted spinoff.
Mounting legal costs
With 3M unable to limit liability through Aearo or its healthcare business, the reality is that the company's legal risk has risen to catastrophic heights. With roughly 230,000 lawsuits at an estimated $50,000 to $400,000 in damages a piece, some quick math would suggest that 3M could face $11.2 billion to $92 billion in costs, which would probably mean a dividend cut on the low end and bankruptcy as the worst-case scenario. It's worth mentioning that 3M has publicly denied all liability and rejected accusations that its earplugs offered unfit protection.
Aside from the earplug issue, 3M has also received flak for using per-and polyfluoroalkyl substances (PFAS) -- known as forever chemicals -- in its end products. The Centers for Disease Control and Prevention (CDC) has identified rising levels of PFAS in the U.S. population due to PFAS strains in food, water, and products containing PFAS. Some estimates say that 3M could face up to $30 billion in legal liabilities for its use of PFAS in end products and for infecting grounder water with PFAS.
Playing devil's advocate
As easy as it would be to sell 3M stock now, there's a very simple reason not to. If judges make an example of 3M and drown it in legal debts, then the decision would have short- and long-term consequences in the business world.
If 3M were to file for bankruptcy protection, it could wipe out a significant amount of the value of its stock. 3M has a current market cap of $66 billion. What's more, 3M employees 95,000 people, some of which would likely lose their jobs. Although Chapter 11 bankruptcy proceedings don't destroy the complete value of a company, they do result in capital restructuring that can lead to years of liability payments, as evidenced by BP's 2010 Deepwater Horizon oil spill.
3M should face consequences if it produced defective ear protection and mislead the military about its performance -- as well as for manufacturing products that contain PFAS that subsequentially contaminated groundwater systems. However, it's not that likely the judicial system will be making an example out of 3M or disproportionally punishing 3M relative to other guilty companies. The more likely outcome, in my personal opinion, is that there will be some sort of settlement that provides a middle ground between victims and the corporation. After failing to receive bankruptcy protection and facing opposition to spin off its healthcare division, 3M is probably more motivated to settle now that it is running out of options.
3M has already begun to report its earnings on a generally accepted accounting principles (GAAP) basis, as well as adjustments that account for legal-related costs. The adjusted earnings show that 3M's business, independent of the legal costs, remains incredibly profitable despite years of slowing growth.
3M stock has fallen far enough
The bear case for 3M would argue that there is much more pain ahead. The bull case is that this is a diversified company that generates a lot of free cash flow and has a 4.8% dividend yield. There's nothing wrong with waiting to let the legal dispute play out before hitting the buy button. But with the stock at a nine-year low, investors are getting a good price for this 120-year-old company.