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Buy 3M Stock Today To Retire In Safety And Splendor Tomorrow (NYSE:MMM)


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This article was co-produced with Dividend Sensei.

The correction of 2022 is largely due to the market focusing on three risk factors.

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YCharts

First, there’s the Russian invasion of Ukraine, which has caused Ukraine to declare a state of emergency and enact a conscription order for all males 18 to 60 years old.

Next, there are concerns about the Federal Reserve raising interest rates and shrinking its balance sheet about 10X faster than last time.

And finally, there’s the fact that the market is still historically overvalued, even after an 11% correction.

Year

EPS Consensus

YOY Growth

Forward PE

Blended PE

Overvaluation (Forward PE)

Overvaluation (Blended PE)

2021

$206.01

50.16%

23.3

23.2

35%

32%

2022

$223.41

8.45%

19.3

21.3

12%

21%

2023

$246.23

10.21%

17.5

18.4

2%

4%

2024

$274.53

11.49%

15.7

16.6

-9%

-6%

12-Month forward EPS

12-Month Forward PE

Historical Overvaluation

PEG

25-Year Average PEG

S&P 500 Dividend Yield

25-Year Average Dividend Yield

$225.41

19.097

13.47%

2.25

3.62

1.43%

2.01%

(Source: DK S&P 500 Valuation And Total Return Tool) updated weekly

In fact, according to JPMorgan, it would take another 11% decline for stocks to return to historical fair value.

But do you know what?

Blue-chip investors in 3M (MMM) don’t have to worry about these risk factors.

3M was founded in St. Paul, MN, in 1902. Since then it’s:

  • prospered through over a dozen restructurings,

  • survived 23 recessions,

  • survived 2 depressions,

  • survived inflation ranging from -2.5% to 15%, and

  • survived interest rates ranging from 0.5% to 16%.

3M’s dividend growth streak began in 1958 (64-years) and has survived through many economic, industry, and company crises as well.

Today I wanted to highlight the four reasons why it’s a potentially great time to add this Ultra SWAN quality dividend king to your portfolio.

In fact, it’s actually the best time in three years to buy 3M, and if you buy at today’s highly attractive valuations, you’ll be well on your way to retiring in safety and splendor in the coming years and decades.

Reason One: Market Is Likely Overreacting To 3M’s Legal Liability Risk

Ultra SWAN quality dividend kings don’t become 30% undervalued without some kind of fear, uncertainty, and doubt.

“The analyst establishes a framework for liabilities related to Combat Arms earplugs with a base case of $14B, with a best-case scenario of $2B and worst case of $53B.” – Seeking Alpha

Morgan Stanley recently cut 3M to “sell” worried about approximately $24 billion in legal liabilities, worst-case about $83 billion.

Probability weighted estimates are a lot lower than the worst-case scenario.

“The environmental liabilities are front and center. “You can’t have that many factories making that many chemical-based products and not have some problems,” Melius Research analyst Scott Davis said in an interview.” – Bloomberg

In 3M’s case, the problems could be enormous. 3M manufactured certain PFAS compounds for decades and used them in products including Scotchgard and firefighting foams before phasing out production starting in 2000. The substances have been linked to cancer and immune system dysfunction, sparking a groundswell of lawsuits and growing attention from the Environmental Protection Agency.

Barclays Plc analyst Julian Mitchell pegs 3M’s potential PFAS liability at $9.6 billion based on probability-weighted estimates for legal settlements and remediation expenses.

Others have estimated 3M could be on the hook for $30 billion in the worst-case scenario. No one truly knows how big this liability might eventually be.

“There is no investor communication strategy to put these issues into perspective,” JPMorgan Chase & Co. analyst Steve Tusa wrote in an October report downgrading the stock to neutral.” – Bloomberg

The FDA is planning on new PFAS regulations in mid-2023 and 3M is also facing approximately 300,000 lawsuits for earplug litigation.

Large litigating risk has always been part of 3M’s risk profile and is now the only thing Wall Street seems to care about.

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Bloomberg

Class action lawsuit headlines are often terrifying, and almost all are reduced by 50% to 99% or overturned by appeals courts.

  • Most class action settlements are paid over 15 to 30 years

  • 3M’s post-dividend retained free cash flow is currently $2.5 billion per year

  • $37.5 to $75 billion over the next 15 to 30 years (not counting future growth)

  • By 2024 analysts expect $3.5 billion in annual post-dividend retained FCF

  • $52.5 billion to $105 billion in legal settlement capacity (and growing steadily over time)

  • vs. $83 billion worst-case estimate from Morgan Stanley.

Barclays estimates 3M will actually pay $9.6 billion over time, at a rate of $320 million to $640 million per year – 13% to 26% of current post-dividend retained free cash flow.

What about the earplug litigation? Well, that’s potentially similar to the Johnson & Johnson (NYSE:JNJ) talcum powder litigation which the company is currently trying to settle for $4.6 billion.

  • Worst case 3M’s total liabilities are about $60 billion over 30 years

  • vs. $75+ billion post-dividend retained FCF

  • This litigation risk is NOT a significant risk to 3M’s dividend safety or long-term growth thesis:

“Litigation fears are an overhang on 3M’s stock, which we believe is responsible for the persistent price-to-value gap. Still, we think the market somewhat fails to appreciate 3M’s short-cycle nature that benefits during the early stage of a recovery. Furthermore, we think litigation fears are overblown…

As for 3M’s combat arms litigation, we earmark a liability of just over $3 billion based on inflation adjusted comparable cases and the number of cases pending.” – Morningstar (emphasis added)

“Moody’s Investors Service (“Moody’s”) has changed the outlook for 3M Company (“3M”) to stable from negative and affirmed all ratings for the company, including 3M’s A1 senior unsecured debt rating and Prime-1 short-term rating.

With strong market demand supporting growth and continued conservative financial policies, 3M has restored credit metrics, leverage in particular, back to stronger levels that support the A1 rating,” says David Berge, Moody’s Senior Vice President and lead analyst for the company. “Nonetheless, the uncertainty around the amount and timing of payments relating to PFAS liabilities will remain a credit concern for years to come.” – Moody’s February 16th, 2022

Rating agencies are well aware of the litigation risk that is baked into their credit and risk ratings.

This article will show:

  • why credit rating agencies are not overly concerned about the litigation risks

  • why risk rating agencies are not overly concerned

  • why bond investors are not overly concerned

  • why the 23 analyst consensus is not overly concerned

  • why management isn’t overly concerned

Basically, the expert consensus and preponderance of evidence indicate 3M is NOT a broken thesis value trap.

  • Note that 3M’s legal liabilities are NOT going to be solved overnight

  • This bear market could last for several years

  • Anyone owning 3M has to be patient and understand this coiled spring could take a long time to pop

  • It’s going to take patience for this investment thesis to play out

  • Momentum traders should look elsewhere

Reason Two: 3M Is One Of The Highest Quality Dividend Stocks In The World

The Dividend Kings’ overall quality scores are based on a 237-point model that includes:

  • Dividend safety

  • Balance sheet strength

  • Credit ratings

  • Credit default swap medium-term bankruptcy risk data

  • Short and long-term bankruptcy risk

  • Accounting and corporate fraud risk

  • Profitability and business model

  • Growth consensus estimates

  • Historical earnings growth rates

  • Historical cash flow growth rates

  • Historical dividend growth rates

  • Historical sales growth rates

  • Cost of capital

  • Long-term risk-management scores from MSCI, Morningstar, FactSet, S&P, Reuters/Refinitiv and Just Capital

  • Management quality

  • Dividend friendly corporate culture/income dependability

  • Long-term total returns (a Ben Graham sign of quality)

  • Analyst consensus long-term return potential

It actually includes over 1,000 metrics if you count everything factored in by 12 rating agencies, we use to assess fundamental risk.

How do we know that our safety and quality model works well?

During the two worst recessions in 75 years, our safety model predicted 87% of blue-chip dividend cuts during the ultimate baptism by fire for any dividend safety model.

How does 3M score on one of the world’s most comprehensive safety models?

3M Dividend Safety

Rating

Dividend Kings Safety Score (147 Point Safety Model)

Approximate Dividend Cut Risk (Average Recession)

Approximate Dividend Cut Risk In Pandemic Level Recession

1 – unsafe

0% to 20%

over 4%

16+%

2- below average

21% to 40%

over 2%

8% to 16%

3 – average

41% to 60%

2%

4% to 8%

4 – safe

61% to 80%

1%

2% to 4%

5- very safe

81% to 100%

0.5%

1% to 2%

MMM

94%

0.5%

1.3%

Risk Rating

Low-Risk (87th industry percentile consensus)

A+ negative outlook credit rating 0.6% 30-year bankruptcy risk

20% OR LESS Max Risk Cap Recommendation

Long-Term Dependability

Company

DK Long-Term Dependability Score

Interpretation

Points

Non-Dependable Companies

21% or below

Poor Dependability

1

Low Dependability Companies

22% to 60%

Below-Average Dependability

2

S&P 500/Industry Average

61% (58% to 70% range)

Average Dependability

3

Above-Average

71% to 80%

Very Dependable

4

Very Good

81% or higher

Exceptional Dependability

5

MMM

88%

Exceptional Dependability

5

Overall Quality

MMM

Final Score

Rating

Safety

94%

5/5 very safe

Business Model

90%

3/3 wide moat

Dependability

88%

5/5 exceptional

Total

92%

13/13 Ultra SWAN dividend king

Risk Rating

3/3 Low Risk

20% OR LESS Max Risk Cap Rec (Highly Speculative Startup)

5% Margin of Safety For A Potentially Good Buy

3M: The 25th Highest Quality Master List Company (Out of 509) = 95th Percentile

The DK 500 Master List includes the world’s highest quality companies including:

  • All dividend champions

  • All dividend aristocrats

  • All dividend kings

  • All global aristocrats (such as BTI, ENB, and NVS)

  • All 13/13 Ultra Swans (as close to perfect quality as exists on Wall Street)

  • 47 of the world’s best growth stocks (on its way to 50)

3M’s 92% quality score means it’s similar in quality to such blue-chips as

  • Lowe’s (LOW) – dividend king

  • Amazon (AMZN)

  • Cummins (CMI)

  • Stanley Black & Decker (SWK) – dividend king

  • Visa (V)

Even among the most elite companies on earth, 3M is higher quality than 95% of them.

Why?

Well for one thing its dividend growth streak of 64 years is more than 3X longer than the 20+ year Ben Graham standard of excellence.

3M is a multinational conglomerate that has operated since 1902 when it was known as Minnesota Mining and Manufacturing. The company is well-known for its research and development laboratory, and the firm leverages its science and technology across multiple product categories.

As of 2020, 3M is organized into four business segments: safety and industrial, transportation and electronics, healthcare, and consumer. Nearly 50% of the company’s revenue comes from outside the Americas, with the safety and industrial segment constituting a plurality of the firm’s net sales. Many of the company’s 60,000-plus products touch and concern a variety of consumers and end markets.” – Morningstar

3M is a highly diversified company with 58% of sales from outside the US.

Investment Thesis Summary

“In our view, 3M is a GDP-plus business. We attribute 3M’s ability to remain ahead of GDP based on its suite of innovative products that are a byproduct of its R&D efforts….

The firm’s proprietary secrets are closely held as 3M rarely grants licenses, yet its technology is difficult to imitate. As a result, 3M typically charges a 10% to 30% price premium relative to the market. 3M’s ability to adapt its technology into multiple use cases also gives it economies of scope, which helps reduce overall unit costs, evident in its superior gross margins.

We believe the firm can grow its top line over 4% over the medium-term thanks to broad-based strength, even as respirator sales now become a near-term headwind. With the more recent acquisitions of workflow solutions provider MModal and negative wound care solutions provider Acelity, we believe the firm can capitalize on the stable and ever-growing healthcare market… we think the firm is well-positioned in some higher-growth markets.” – Morningstar (emphasis added)

3M’s current restructuring is designed to cut annual costs by $250 million per year.

The company’s capital allocation plan is focused on

  1. organic growth

  2. the dividend

  3. M&A

  4. opportunistic buybacks

3M is guiding for 3.5% sales growth and 3% EPS growth in 2022, a year of both tough comps and ongoing supply chain headwinds.

3M’s total addressable markets are approximately $300 billion in size.

To give you an idea of what kind of growth markets 3M is targeting

From screen technology to consumer electronics to data centers, 3M has many long and large growth runways to drive the 4% long-term sales growth that analysts and management expect.

3M expects to have about $14.5 billion of cash to work with in 2022 and plans to spend $3.4 billion of that on dividends (60% of consensus free cash flow).

Bottom Line: There is little indication that 3M’s historic growth rates can’t be achieved in the future.

And guess what else 3M has to fall back on when dealing with litigation risk or any other challenges?

3M Credit Ratings

Rating Agency

Credit Rating

30-Year Default/Bankruptcy Risk

Chance of Losing 100% Of Your Investment 1 In

S&P

A+ negative outlook

0.60%

166.7

Moody’s

A1 (A+ Equivalent) stable

0.60%

166.7

Consensus

A+ stable outlook

0.60%

166.7

(Source: S&P, Moody’s)

We recently downgraded 3M to ‘A+’ from ‘AA-‘ due to higher-than-expected leverage as well as potential environmental liabilities related to perfluoroalkoxy alkanes (PFAS). The outlook is negative.” – S&P

Negative outlook = 33% chance of a downgrade (to A).

“Moody’s Investors Service (“Moody’s”) has changed the outlook for 3M Company (“3M”) to stable from negative and affirmed all ratings for the company, including 3M’s A1 senior unsecured debt rating and Prime-1 short-term rating.

With strong market demand supporting growth and continued conservative financial policies, 3M has restored credit metrics, leverage in particular, back to stronger levels that support the A1 rating,” says David Berge, Moody’s Senior Vice President and lead analyst for the company. “Nonetheless, the uncertainty around the amount and timing of payments relating to PFAS liabilities will remain a credit concern for years to come.” – Moody’s February 16th, 2022

3M Leverage Consensus Forecast

Year

Debt/EBITDA

Net Debt/EBITDA (3.0 Or Less Safe According To Credit Rating Agencies)

Interest Coverage (8+ Safe)

2021

2.15

1.62

13.72

2022

1.87

1.38

15.16

2023

1.75

1.09

17.53

2024

1.64

0.70

18.89

2025

1.69

0.47

19.08

Annualized Change

-5.79%

-26.76%

8.60%

(Source: FactSet Research Terminal)

3M’s strong balance sheet is getting steadily stronger over time.

3M Balance Sheet Consensus Forecast

Year

Total Debt (Millions)

Cash

Net Debt (Millions)

Interest Cost (Millions)

EBITDA (Millions)

Operating Income (Millions)

Average Interest Rate

2020

$18,795

$4,634

$14,161

$499

$8,755

$6,844

2.65%

2021

$17,363

$4,564

$12,799

$486

$9,284

$7,369

2.80%

2022

$16,864

$5,875

$10,532

$437

$9,634

$7,659

2.59%

2023

$16,652

$7,069

$7,092

$434

$10,157

$8,197

2.61%

2024

$18,087

$9,903

$4,978

$456

$10,695

$8,700

2.52%

2025

$19,546

NA

NA

NA

NA

$8,541

NA

2026

$20,307

NA

NA

NA

NA

$8,888

NA

Annualized Growth

1.30%

20.91%

-23.00%

-2.23%

5.13%

4.45%

-1.28%

(Source: FactSet Research Terminal)

Debt is expected to rise slower than cash flow growth and cash is growing at 21% per year.

Long-term borrowing costs are expected to remain stable even as long-term rates increase.

3M Bond Profile

  • $9 billion in liquidity

  • well-staggered debt maturities (little problem refinancing maturing bonds)

  • 100% unsecured bonds (maximum financial flexibility)

  • bond investors so confident in 3M’s long-term prospects they are willing to lend to it for 28 years at 3.6%

  • the average borrowing cost is 2.53%

  • 0.3% after inflation vs 18.1% cash returns on invested capital

3M Credit Default Swaps: Bond Market’s Real-Time Fundamental Risk Assessment

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FactSet

Credit default swaps are insurance policies bond investors take out against potential defaults.

  • a real-time fundamental risk-assessment

  • MMM’s CDS imply an A- credit rating

  • fundamental risk has risen modestly in recent months

  • but bond investors are not particularly worried about how litigation risk causing increased default risk

  • other than 1-year default risk (currently 0.07%) fundamental risk has been stable for all short to medium-term time periods

  • bond investors, rating agencies, management, and analysts agree that 3M’s thesis remains intact

3M Profitability: Wall Street’s Favorite Quality Proxy

3M’s profitability is historically in the top 10% of peers.

3M Trailing 12-Month Profitability Vs Peers

Metric

Industry Percentile

Major Conglomerates More Profitable Than 3M (Out Of 506)

Operating Margin

88.87

56

Net Margin

83.81

82

Return On Equity

96.51

18

Return On Assets

93.87

31

Return On Capital

86.20

70

Average

89.85

51

(Source: Gurufocus Premium)

Despite many supply chain disruptions caused by the pandemic, profitability was in the top 10% of peers in the last year.

Adjusting for the natural cyclicality of this industry 3M’s profitability is relatively stable over the last 30+ years, confirming its wide and stable moat.

3M Profit Margin Consensus Forecast

Year

FCF Margin

EBITDA Margin

EBIT (Operating) Margin

Net Margin

Return On Capital Expansion

Return On Capital Forecast

2020

20.5%

27.2%

21.3%

15.8%

1.03

2021

16.5%

26.3%

20.8%

16.7%

TTM ROC

56.98%

2022

15.9%

26.4%

21.0%

16.4%

Latest ROC

50.20%

2023

16.6%

26.8%

21.6%

16.8%

2026 ROC

58.80%

2024

17.3%

27.1%

22.0%

16.9%

2026 ROC

51.80%

2025

17.7%

0.0%

21.4%

17.4%

Average

55.30%

2026

18.4%

0.0%

21.5%

17.5%

Industry Median

12.15%

Annualized Growth

-1.80%

-0.13%

0.19%

1.75%

MMM/Peers

4.55

Vs S&P

3.79

(Source: FactSet Research Terminal)

3M’s margins are expected to remain stable in the coming years.

And returns on capital, Joel Greenblatt’s gold standard proxy for quality and moatiness are similarly expected to be stable.

In fact, 3M’s ROC is expected to be nearly 5X higher than its industry peers and almost 4X higher than the S&P 500.

According to Joel Greenblatt’s favorite quality metric, 3M is nearly 4X higher quality than the average S&P 500 company.

3M Growth Spending Consensus Forecast

Year

SG&A (Selling, General, Administrative)

R&D

Capex

Total Growth Spending

Sales

Growth Spending/Sales

2020

$6,929

$1,878

$1,501

$10,308

$32,184

32.03%

2021

$7,197

$1,994

$1,603

$10,794

$35,355

30.53%

2022

$7,408

$2,110

$1,836

$11,354

$36,519

31.09%

2023

$7,618

$2,192

$1,928

$11,738

$37,898

30.97%

2024

$7,962

$2,407

$1,941

$12,310

$39,518

31.15%

2025

$7,952

NA

$1,996

NA

$39,928

NA

2026

$8,202

NA

$2,066

NA

$41,326

NA

Annualized Growth

2.85%

6.40%

5.47%

4.54%

4.26%

-0.69%

(Source: FactSet Research Terminal)

Analysts expect steady increases in growth spending, rising from $10.8 billion in 2021 to $12.3 billion in 2024. Yet margins are expected to remain stable.

3M Dividend Growth Consensus Forecast

Year

Dividend Consensus

FCF/Share Consensus

Payout Ratio

Retained (Post-Dividend) Cash Flow

Buyback Potential

Debt Repayment Potential

2021

$5.89

$10.21

57.7%

$2,471

2.93%

14.2%

2022

$6.04

$8.63

70.0%

$1,481

1.76%

8.5%

2023

$6.27

$9.82

63.8%

$2,031

2.41%

12.0%

2024

$6.37

$12.53

50.8%

$3,524

4.18%

21.2%

Total 2021 Through 2024

$24.57

$41.19

59.7%

$9,506.64

11.28%

54.75%

Annualized Rate



Read More: Buy 3M Stock Today To Retire In Safety And Splendor Tomorrow (NYSE:MMM)

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