Industrial conglomerate and world-renowned dividend stock 3M Company (MMM 0.46%) has suffered a fall from grace that's taken shares over 60% from their highs, last seen in early 2018.
The culprit? An expensive and catastrophic double-whammy of class action lawsuits for defective earplugs used in the military and contaminated drinking water supplies due to PFAS ("forever") chemicals 3M has manufactured for decades. The settlements will combine for at least $16 billion, a financial dark cloud hanging over the company's head.
Now trading near its lowest price since 2010, could the stock beat the broader market moving forward?
Believe it or not, there's a realistic path to the stock doubling over the next five years.
Here is how.
Taking 3M's pulse as it stands today
Change will occur at 3M over the next 12 to 24 months. The company is navigating significant litigation settlements and spinning off its healthcare business during the first half of this year. Management has already stated that it plans to hold a presentation following the spin-off to update investors on the company's status and long-term plans.
Still, investors can soak up information from the company's current affairs. For starters, 3M will spend the next few years laying the groundwork to get through the settlement obligations stemming from its lawsuits for defective earplugs and PFAS chemicals. The earplug lawsuit should cost around $5 billion in cash and another $1 billion in company stock, paid through 2029. Meanwhile, the PFAS chemicals suit settled for as much as $12.5 billion and will be paid over 13 years.
For a company generating $5 billion in annual cash flow, that will significantly drain 3M's financials for years. Since 3M spends $3.3 billion on its dividend each year, that leaves little, if anything, left over if management were to pay its settlements out of cash flow.
MMM Free Cash Flow data by YCharts
3M is a Dividend King with a remarkable 65 consecutive years of dividend growth. Management recently increased the payout by a penny to keep its streak alive, but it may be best to reduce the dividend to free up cash.
Looking beyond the litigation, 3M's business has struggled for several years now. Both 3M's operating profit margin and return on invested capital, a measure of how much the company generates on the resources it invests, have notably declined since 2018.
MMM Operating Margin (TTM) data by YCharts
Management unveiled some long-term financial goals in 2018, including 8% to 11% earnings growth and a 20% return on invested capital. However, as the chart above shows, that didn't pan out as well as planned. Will spinning off the healthcare unit help? Only time will tell.
The most realistic path to investor returns
Obviously, paying billions of dollars to settle lawsuits isn't ideal. But the good thing about hitting rock bottom is that it's much easier to go up. Before the litigation, 3M was a blue chip stock with a decades-long earnings and dividend growth track record. Years ago, before the stock peaked in 2018, it averaged a long-term price-to-earnings ratio of about 20.
Today, the stock trades at half that valuation. Want to double the stock price? Convince the market that 3M is worth trading at 20 times earnings again.
It's not as outlandish as it sounds. It's not that 3M's core business is necessarily busted. While management needs to get the business to perform better, it's still a highly diversified industrial conglomerate that sells thousands of products to end markets, ranging from office supplies to automotive. Is the business growing? Not exactly. 2023 revenue declined 3% from 2022.
Fortunately, management is guiding for flat to 2% revenue growth this year, so things are stabilizing. Analysts are pretty optimistic as well. The consensus is that 3M will grow earnings between 4% and 7% annually over the next few years.
Put the litigation in the rearview mirror, add some better execution by leadership, and Wall Street could be looking at a well-known business growing earnings at a mid-to-high single-digit rate. A smaller dividend could free up the cash flow to keep 3M financially healthy.
That's the hope.
This will take time
Remember, things could be murky for the next year or so. 3M is spinning off its healthcare division, and the dust needs to settle on the company's litigation settlement payouts. But there's a scenario where the smoke clears, and knowing all the answers gives Wall Street more confidence in 3M's long-term future.
That said, it seems reasonable that 3M will be on much firmer ground in five years. By then, 3M will have paid out most of its earplug settlement, and the PFAS expenses will be finalized (the EPA is requiring three years to test additional water systems).
Of course, buying the stock on hope and optimism is a risky endeavor in itself. But 3M has historically been a resilient company that's rewarded investors. The potential reward could be worth the risk if you buy this stock as part of a well-diversified portfolio.
