3 Things You Need to Know if You Buy 3M Stock Today

3M's (MMM 0.46%) dividend yield of almost 6.5% naturally attracts dividend-seeking investors. There's also a potential turnaround story in progress as management continues to restructure the company for profitable growth. But is the stock a good buying opportunity at the moment?

Let's take a balanced look at the company, at the stock, and at three things you need to know before you make a decision.

1. 3M's margins are improving

The company's operating profit margin has been a constant source of frustration over the years. It's one thing to have disappointing sales growth, as 3M has had in recent years, but it's a lot worse when declining profit margins accompany it. I would argue that declining profit margins are a bright red flag for investors.

It's no coincidence that 3M's stock price is down 25% over the last decade, while its industrial peer Illinois Tool Works' stock price is up 200%. In that period, 3M's operating margin went from 21.6% in 2013 to 19.1% at the end of 2022, compared to Illinois Tool Works, which went from 17.8% to 23.8% over the same period. Over that time both companies' overall revenue only grew by a low-teens percentage over that decade.

The bottom line: Margins matter.

3M's margins have become a watch item among investors and analysts. Despite previous restructuring actions, substantive acquisitions, and disposals (mainly in the healthcare business set to be spun off), and ongoing investment in research & development, 3M continues to suffer margin pressure.

However, there are some tentative shoots of recovery in progress. Earlier this year, management launched another restructuring plan to reduce headcount, reduce management layers, streamline its operations, and simplify its supply chain.

The good news is these actions appear to be having a positive impact, with CFO Monish Patolawala noting on the last earnings call in late October that at the start of the fiscal year, "we had said margin rates for the year are going to be around 19%." By the end of the second quarter, "we said margin rates are going [to be] between 19.5% to 20%," but now the midpoint of its guidance calls for a margin rate of around 20%. Fast forward to his presentation at the Baird Global Industrial Conference, and now "it's 20% plus."

That's not a bad result in a year when organic sales growth is set to come in at the bottom of its initial sales range of flat to a decline of 3%.

Image source: Getty Images.

2. 3M's sales remain under pressure

As noted above, 3M's sales outlook deteriorated through the year. In a nutshell, rising interest rates put pressure on consumer discretionary spending. That has a direct impact on 3M's consumer-facing businesses and also an impact on its customers in key industries like consumer electronics.

These negative trends can be seen in the fact that the only segment to report quarter-on-quarter sales growth in 2023 is the healthcare segment. And that's the segment set to be spun off.

Patolawala said he believes there are "signs of stabilization in consumer electronics." Still, it's worth noting that others reported weakening spending trends in key end markets for 3M, like the automotive sector. Meanwhile, the strong growth rates in aerospace spending in 2023 will set up challenging comparisons in 2024.

Don't be surprised if 3M gives another weak sales outlook for 2024 when it next reports earnings, especially as the healthcare segment is set to be spun off in the first half of 2024.

Data source: 3M presentations.

3. 3M's valuation is attractive, but the dividend is at risk

3M's current dividend yield is 6.2%, and the midpoint of its full-year adjusted earnings-per-share (EPS) outlook is $9.05, putting the stock on a price-to-earnings ratio of just 10.2 times 2023 earnings. That's a highly attractive valuation.

Image source: Getty Images.

However, 3M's trailing-12-month dividend payout was $3.3 billion, and its free cash flow was $4.85 billion. The dividend is sustainable on that basis, but note that 3M has to pay $5 billion in cash and $1 billion in stock over the next six-to-seven years to settle legal action over faulty military-grade earplugs. In addition, there's a $10 billion to $12.5 billion settlement paid over 13 years to be settled due to legal actions over poly fluoroalkyl substances (PFAS). Some back-of-envelope calculations suggest an initial cash call of $1.5 billion annually, making sustaining its dividend tough.

Is 3M a stock to buy?

Despite some positive signs on margins, there's a real risk that 3M will cut its dividend. The company needs its end markets to turn around quickly to convince investors its turnaround is successful. On balance, I think the stock is best avoided until there's more clarity on how it's shaping up for 2024, especially in regard to its dividend.