3M (MMM -0.66%) is a huge conglomerate with over 60,000 industrial and consumer products, including such well-known names as Scotch tape, Post-it notes, and more. The company's diverse offerings have helped support steady dividend growth over time. In fact, 3M is one of the longest-tenured Dividend Kings. After last week's dividend raise, it is on track to have paid and raised its dividend for an impressive 65 straight years.
Yet 3M stock has been under intense pressure lately due to litigation involving its faulty Combat Arms earplugs and use of per- and polyfluoroalkyl substances (PFAS). And to make matters worse, the company has posted earnings miss after earnings miss, stagnating to declining growth, and has a bloated cost structure that has left it vulnerable to inflation and supply chain challenges.
3M's fourth-quarter 2022 earnings miss added more pressure to the stock, knocking it back down near a 10-year low. Let's weigh the good and the bad to see if 3M is worth buying or if the stock sell-off simply isn't enough to justify the risks.
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3M's business is not doing well
3M is a great example of why a large, industry-leading company isn't automatically a stable business. It continues to exhibit an inability to properly forecast. And for that reason, it has lost the benefit of the doubt and investors should take its guidance with a grain of salt, or simply expect results to be on the low range of expectations.
For 2023, 3M expects 2% to 6% of adjusted sales decline, adjusted earnings per share of $8.50 to $9 compared to $9.88 in 2022, operating cash flow of $5.8 billion to $6.3 billion, and free cash flow (FCF) conversion of 90% to 100%. Taking the pessimistic side of these estimates, we can figure a 6% decline in sales, a 14% decline in earnings down to $8.50 per share, and FCF conversion of 90% on $5.8 billion in operating cash flow for $5.22 billion in 2023 FCF. In short, 3M's turnaround has not come to fruition as the business continues to struggle.
The valuation is very attractive
At first glance, the disappointing performance paired with terrible guidance makes the stock an easy pass or even a sell. The catch is that if we zoom out and look at 3M's stock price compared to its fundamentals, it quickly looks too cheap to ignore.
For example, 3M's stock price is near a 10-year low. And even though its earnings are falling, they are still on the high side over the last decade. The same goes for revenue. And FCF in excess of $5 billion is plenty to cover the dividend, which cost 3M $3.37 billion in 2022.
Data by YCharts.
Even if we assume the low end of earnings guidance at $8.50 per share, the stock would still have an inexpensive valuation with a forward price-to-earnings ratio of 13.4.
What's more, 3M's balance sheet is in good shape. The company's debt-to-capital (D/C) ratio is a respectable 52%, which is around the same as other industrial conglomerates like General Electric and Honeywell, and quite a bit lower than a company like Illinois Tool Works, which has a D/C ratio over 70%. D/C is a useful metric for determining a company's degree of leverage and reliance on debt relative to its debt and equity.
3M's net total long-term debt position is also quite low for its size. And it's done a great job paying down debt over the past few years.
Data by YCharts.
In sum, 3M is not a financially distraught company whose business is falling apart. Rather, it's a company that is undergoing a painful one-two punch of macroeconomic and self-inflicted challenges but has retained its structural integrity.
A passive income powerhouse
Last week, 3M announced a dividend raise of one cent per share per quarter -- bringing the quarterly dividend to a nice round $1.50 per share or $6 per share per year. It marks the fourth consecutive year that 3M has raised its dividend by one cent, which it is likely doing so that it maintains its Dividend King status.
As much as investors want to see larger dividend raises, 3M is probably better off using FCF to keep improving the balance sheet and get the business back on track. Especially considering the dividend yield is already a sizable 5.2% -- far higher than most Dividend Kings and higher than the risk-free 10-year Treasury bill rate of 3.7%.
Investors can count on 3M to keep making these negligible dividend raises despite its revenue and earnings declines given that its FCF and balance sheet can support the dividend and the company is protective of its Dividend King status.
3M stock is a buy
The investment thesis for 3M has always been centered on its dividend. And with the yield far above historical levels, the question for passive income investors is whether the business will keep declining to the point at which capital losses offset dividend payments.
Given how far the stock has fallen, I think the investment thesis for 3M is straightforward at this point. It's a legacy business whose legal woes have clashed with macroeconomic headwinds at a bad time. But its balance sheet is actually quite good, its valuation is cheap for its size and brand power, and its dividend yield is high.
And for those reasons, the good outweighs the bad and even the ugly for 3M.
