A Dividend Cut Will Make 3M a Buy

The subject of 3M's (MMM 0.46%) dividend came up again during a Citigroup industrial conference where 3M's management team fell short of strongly affirming it would maintain it at current levels. As such, I thought I'd share some thoughts on the issue and lay out some numbers so readers can make up their minds.

Management's commentary

Citigroup analyst Andrew Kaplowitz asked 3M management if it had any thoughts on the dividend in light of the release of a Form 10 SEC filing related to the upcoming spinoff of the healthcare business Solventum. As a reminder, Solventum is a cash-generative and relatively stable business, particularly when compared to 3M's remaining three segments, which tend to be more cyclical and rely on the economy. It's also the only segment to report sales growth last year.

3M CEO Mike Roman's reply reiterated the company's financial strength and cash-flow potential (more on that in a moment) and referred to a capital allocation policy that "means investing in the business" and "continues to be the priority." The remaining company would in a position to meet litigation matters and "to return cash to shareholders and value to shareholders including through a dividend, paying an attractive dividend."

That commentary falls short of explicitly stating the dividend would be maintained at the current level. However, we are not privy to any discussions management may have with its board of directors, and there are still known unknowns, such as the impact of legal costs and liabilities. In addition, estimating the value of the 3M's 19.9% stake it will retain in Solventum (which could be sold to raise cash) is also tricky.

Roman could intend to maintain the dividend, but strongly confirming that might put him in a difficult situation given the math around the company's finances.

Image source: Getty Images.

3M's cash flow

The stock yields 6.6%, and its dividend payout to shareholders in 2023 was $3.3 billion. Keep that figure in mind.

Before getting to the table below, note the following:

• These numbers, both the reported figures for 2023 and the guidance for 2024, include Solventum, an important point I'll return to.
• "Special items" refers to net costs for significant litigation, divestiture impacts, and other items. No guidance is given for special items in 2024.

Free cash flow (FCF) is a non-GAAP measure, so there are different conventions for reporting it. 3M's management gave an adjusted FCF figure of $6.3 billion for 2023. That's fair enough because you might not expect "special items" to repeat. However, FCF to the company is closer to $5.2 billion (as in the table below) after special items are taken out.

Whether you accept $6.3 billion or $5.2 billion, both figures easily cover the $3.3 billion needed to pay the dividend. However, there's more to the story.

Data source: 3M presentations.

3M dividend's sustainability

First, 3M won't have FCF from Solventum for the full year. Digging into the Form 10 filing, Solventum generated $1.9 billion, $1.4 billion, and $1.6 billion in FCF in the last three years. Since 3M's management expects it to generate flat to low-single-digit revenue growth in 2024, penciling in $1.6 billion for Solventum in 2024 is reasonable.

Second, given the ongoing legal issues at 3M, it's highly likely that there will be some drain on cash from special items in 2024. In addition, the 2024 guidance does not include costs associated with the spinoff.

Third, 3M has multibillion-dollar cash calls coming from legal settlements with CFO Monish Patolawala previously outlining "$5 billion in cash and $1 billion in stock" for the combat arms earplugs issue to be "paid over the next six to seven years" and a PFAS settlement of "$10.5 billion to $12.5 billion with a present value of $10.3 billion, again, for a payout that's going to be spread over 13 years." 

Taking the $1.6 billion in FCF from Solventum from the estimated $5.2 billion to $5.4 billion out of the estimated 2024 FCF gives you $3.6 billion to $3.8 billion. Suddenly, the $3.3 billion looks much less well covered, even before accounting for special items and legal settlements, as discussed above.

Image source: Getty Images.

Will 3M maintain its dividend?

Based on the arguments above, 3M's dividend payout is under pressure if management relies on paying it out of the ongoing FCF. That said, management expects to receive $7.7 billion in proceeds from the Solventum spinoff, and rating agency Fitch believes the remaining 19.9% stake in Solventum could be worth $3.5 billion to $5 billion.

These sources of cash could be used to support the current payout, so 3M certainly can cover its dividend. Still, it probably makes more sense for management to bite the bullet and cut the dividend. That will remove a lot of uncertainty around the stock, making it more attractive for investors.