Share prices of industrial giant 3M (MMM 0.46%) are down more than 50% from their 2018 highs. Numerous issues have led to this decline, but the really big ones involve legal issues. Where things go from here, meanwhile, will change dramatically in 2024 if the company's current plans play out as expected.
Weak performance and so much more at 3M
Historically, 3M was regarded as a highly innovative industrial company with a long history of growth behind it. However, the company's growth hasn't been all that impressive of late, and questions have arisen about its stagnating ability to innovate. As you might expect, investors have been downbeat about such issues. Still, businesses go through cycles of good times and bad times, so this alone isn't the end of the world.
Image source: 3M.
The other headwind for the stock has been legal. The company faces product liability and environmental lawsuits, both having already resulted in billions of dollars in costs and settlements. And the legal issues aren't over yet, so there will likely be more bad news before 3M's legal troubles are finally resolved. Add that to the weak business performance, and you can see why the stock trades down so far from its recent peak.
In the face of all this, 3M management chose to spin off the medical business. That division accounts for around 25% of the top line, so it is a very big move. It is also one of the company's more profitable business lines, the one that was supposed to be a core growth driver in the future. This is not a small decision. Assuming it happens as planned, 3M will end 2024 a vastly different company from when it entered the year.
Why would 3M spin off healthcare?
There are two good reasons to spin off healthcare. First, it will protect the division from the legal issues facing the rest of the company. Second, and perhaps more importantly, it will allow 3M to raise cash to pay for its legal issues. That should position the company for a brighter future, even though it is jettisoning what you might call a crown jewel asset.
That brighter future, though, will likely be less robust than it might otherwise have been. Healthcare was generally expected to grow more quickly than the company's other industrial businesses. 3M was already a slow and steady tortoise, and now that pace could drop to an even slower cadence.
That's probably a net win, given the huge legal costs the company is incurring and is, perhaps, still yet to face. But investors must understand that 3M will probably be on a different growth trajectory after healthcare gets spun off.
The next question, which will be particularly interesting to income investors, is the dividend. 3M is a Dividend King with over six decades of annual dividend increases behind it.
That record sets the company apart from many of its peers. But the payout ratio is negative today thanks to generally accepted accounting principles (GAAP) losses at least partly related to legal issues. Now jettison 25% of its revenue, and it seems highly unlikely that 3M will be able to maintain the current dividend rate after the spin-off.
The best-case scenario is likely to be a 25% dividend reduction. However, with the company trying to deal with heavy costs and slow growth, it could take this moment to reset the dividend policy even lower. There's no way to know what happens, of course, but if you are relying on 3M's dividend, you will want to think through the dividend cut risk very carefully.
Is a smaller and slower 3M desirable?
A lot of bad news has been priced into 3M's stock, even after a big rally at the end of 2023. The question for investors is whether enough bad news has been added to the equation. At this point, it is hard to tell.
Spinning off the healthcare division will help the company, but it might just be at the expense of future opportunities that won't benefit 3M shareholders. 3M looks like a turnaround stock that only more aggressive investors should be considering, with dividend investors treading particularly cautiously concerning the lofty 5.4% dividend yield.
