The story at 3M (MMM 0.46%) is complex today. There is the core business, which hasn't been executing well. There are legal headwinds in the form of forever chemical lawsuits and earplug litigation. And the company is spinning off its sizable healthcare division. That's a lot of intertwining factors for investors to consider as they think about the future.
3M is in a state of flux
At this point, 3M is best viewed as a special situations stock. It probably isn't a great option for most investors. As noted, the industrial company's business hasn't been doing that well. To highlight that fact, sales fell from roughly $8.7 billion in the second quarter of 2022 to $8.3 billion in the same stanza of 2023. But this isn't a new trend; revenue has been pretty stagnant for the past five years. The stock has declined materially over this period.
The company has a long history of innovation, so there's a reason to believe that 3M will eventually figure a way out of its current doldrums. That said, there have been concerns among industry watchers and former 3M employees that the company may have lost its research edge. One of the big problems is that management is faced with a big cash drain in the form of product liability and environmental lawsuits, which may be limiting its ability to invest in innovation.
Without getting too deep into the details, 3M has faced years of legal costs related to earplugs it sold to the military and forever chemicals it produces. It has been making progress on both fronts, but the legal costs are not over. And even when it settles cases, there's a big drain since even more cash has to go out the door. Aside from the costs, legal issues are very difficult for individual investors to track, which materially increases uncertainty.
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Amid all of this, 3M is planning to spin off its healthcare division. This has been viewed as a crown jewel, with higher growth prospects than the rest of its business. There are two potential reasons for this move, neither of which is necessarily great. First, 3M might be looking to shield this division from the legal issues it faces. Second, 3M could view the healthcare spinoff as a way to generate the cash it will need to cover its legal expenses.
Does the healthcare spinoff help or hurt investors?
In the second quarter of 2023, the only division that was able to grow organic sales was 3M's healthcare group. Although the organic sales increase was a tiny 0.1%, that's much better than the declines of 2.2% or greater in the company's other three divisions. Pulling this business out clearly won't be a benefit to the company's operating results right now.
But that's likely to be the case in the future as well since healthcare is expected to be an increasingly important sector of the economy. That's pretty much why 3M started to build this business in the first place. Meanwhile, healthcare represents around 25% of the company's top line. Removing that revenue and the profits that it generates will mean 3M has fewer resources to support its dividend. So, a dividend cut is likely in the cards for 3M.
Given the other headwinds 3M is facing, though, the board might take this opportunity to reset the dividend policy. If that comes to pass, the dividend cut would be larger than the size you might expect from jettisoning a quarter of the company's business. It could be an ugly outcome for income investors.
A stand-alone healthcare division, meanwhile, might be better off in some ways. The biggest being a freer hand to invest in its own business without the heavy weight of 3M's legal costs. Still, there's the risk that 3M will load the spinoff with debt so it can strengthen its own balance sheet. That would put 3M in a slightly better position to deal with its legal issues (it probably won't help the growth story very much) but risk starting the healthcare division off on its back foot. In other words, both companies could end up in less-than-desirable positions.
Watching from the sidelines
The uncertainty around 3M's legal issues led me to sell most of my position in the stock. It should probably keep most investors on the sidelines in what has become a very complex special situation. Management is looking to do what's best for the company, but given the problems it faces, the outcomes here might not be that great for shareholders. And the planned spinoff seems likely to be more negative than positive for 3M and, perhaps, the healthcare unit, too. Until there's more clarity, it seems like watching this situation is a better choice than investing in it.
