News of a multibillion-dollar settlement might not seem likely to drive a stock higher, but that's exactly what happened to 3M (MMM 0.46%) on Monday.
According to Bloomberg, the company has agreed to pay more than $5.5 billion to put to rest long-standing litigation accusing it of selling faulty earplugs to the U.S. military. The agreement will resolve more than 300,000 lawsuits from individuals impacted by the earplugs. 3M would reportedly pay out the sum over a five-year period, though the deal is not yet official as its board hasn't approved it yet.
The stock closed up 5.3% on Monday on the news.
Image source: 3M.
Is the saga finally over?
Lawsuits surrounding the defective earplugs have hampered 3M for years but picked up steam in 2018 when a whistleblower complaint alleged that the company knew that the earplugs didn't work properly but concealed that fact from the military.
According to that complaint, the company knew that its Combat Arms Earplugs Version 2 (CAEv2) weren't long enough to be correctly inserted into service members' ears. Nonetheless, the company still sold the product to the Defense Logistics Agency, and soldiers who used the earplugs reportedly suffered tinnitus and similar conditions.
3M has already agreed to multiple settlements over the years regarding the earplugs, including one with the Justice Department in 2018 for $9.1 million.
However, individuals continued to file lawsuits against 3M, and eventually, more than 300,000 claims were combined into multidistrict litigation (MDL), making it the biggest MDL in history.
To defend itself against the litigation, 3M had at one point broken out the subsidiary responsible for the earplugs, Aearo, into a separate entity and declared bankruptcy, though its bankruptcy filing was dismissed in June by a judge who said its financials didn't warrant a bankruptcy.
3M has yet to officially comment on the settlement, but with the Aearo bankruptcy strategy no longer an option, this seems to be the next best move for the company.
Why investors are cheering the news
Five-and-a-half billion dollars may seem like a steep price tag to resolve the earplugs litigation, but that was actually significantly less than analysts estimated the company would have to pay, as some Wall Street watchers thought that 3M could pay up to $10 billion over the legal claims.
In addition to the less-than-feared settlement value, investors also seem to be reacting favorably to the news because it puts to rest a long-standing legal overhang for the company and removes the risk and uncertainty associated with the lawsuits. Though the multibillion-dollar penalty is costly for 3M, the market tends to prefer a known quantity versus the uncertainty of a larger payment and potentially other consequences.
Investors reacted similarly when 3M settled litigation over pollution in the water supply caused by its PFAS "forever chemicals" in June, agreeing to pay $12.5 billion over a 13-year period.
Like the earplugs litigation, investors were also fearful of the costs and reputational damage from the PFAS charges and were glad to see it resolved.
Is 3M a buy now?
With 3M having resolved two thorny legal issues in just two months, much of the surrounding uncertainty seems to have evaporated even if it comes at a significant cost for the company.
While that news removes some key headwinds facing the company, the conglomerate is still struggling in the current macroenvironment. It was forced to issue two rounds of layoffs earlier this year and reported declining sales in its most recent earnings report with revenue down 4.3%. Organic sales, which exclude acquisitions, divestitures, and currency exchange, fell 2.2%.
In a positive sign, the company hiked its adjusted earnings-per-share (EPS) guidance modestly from $8.50 to $9.00 to $8.60 to $9.10. Meanwhile, investors are anticipating the spin-off of its healthcare divisions by the end of 2023, allowing 3M, which makes a diverse range of products like N95 masks and Scotch tape, to focus on material science and leave a stand-alone healthcare business better aligned with healthcare investors and better positioned to pursue its own strategic goals.
Though 3M has a strong brand name and a legacy of innovation, it's lagged the broad market for the last several years. However, it's worth a closer look for dividend investors as it currently offers a dividend yield of 5.7% at a forward price-to-earnings (P/E) ratio of less than 12.
With the earplug and PFAS litigation behind it, the healthcare spin-off coming up, and a potential return to growth as the economy improves, the stock looks like a promising buy for yield-seeking income investors at the current valuation.
