3M stock: Are 3.7% dividend yield a buy?

The price of the 3M stock has been declining for over 2 years. At the beginning of 2018, the stock price reached its all-time high of 250 USD. Since then the price has been falling. The Corona pandemic has intensified the downward trend and once again put pressure on shareholders. The stock price has since recovered some of the losses, but the all-time high of 2018 is still a long way off. Whether the price drop was justified and if 3M with a dividend yield of 3.7 percent is an attractive buy today, you will find out here.

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The business model: This is how 3M makes money

The 3M Company is a conglomerate based in Minnesota and was founded in 1902. You may know 3M as the inventor of the Post-It notes. 3M is a so-called conglomerate. These are companies that are not only active in one industry, but in many different industries. Other prominent representatives of this category are General Electric and Berkshire Hathaway. Conglomerates were very prominent in the 1960s when acquisitions were seen as a good way to grow a company in times of low interest rates. However, it has become apparent that synergies across completely foreign industries are often difficult to realize. Many of these conglomerates were therefore only profitable thanks to low interest rates and quickly got into trouble when interest rates rose. Nowadays, companies tend to concentrate on their core competencies within one industry. This is why conglomerates are now encountered less frequently.

3M Stock
Logo
Country	USA
Industry	Industrial
Isin	US88579Y1010
Market cap.	91.7 billion USD
Dividend yield	3.7%
Dividend stability	0.94 (max. 1.0)
Earnings stability	0.96 (max. 1.0)

Conglomerates can be more difficult to manage than smaller, specialized companies due to the diversity of their segments. Nevertheless, they offer a valuable advantage: diversification. By merging different segments, diversification effects can be achieved that are not achievable for specialized companies. Imagine an automotive and a pharmaceutical company merging to form a new company. If sales in the automotive industry collapse due to an economic downturn, the company will continue to generate stable earnings from the pharmaceutical division. This can help cushion the downturn. When diversifying within a group, the advantages of greater synergistic effects within the same industries must always be weighed against the advantages of diversification in different industries. Of course, there are also synergy effects in diversified companies, for example within the administration.

At 3M you can see the diversification by the number of different products with which 3M generates its revenues. The company sells 55 thousand (!) different products in the 4 business areas “Safety & Industrial”, “Transportation & Electronics”, “Health Care” and “Consumer”.

Safety & Industrial

In this segment, 3M sells industrial goods such as adhesives and abrasives. 3M also manufactures protective equipment. This includes protective suits and masks for medical staff, which during the Corona Pandemic were considered so important that US President Trump interfered in 3M’s business policy and even prohibited the export of the masks.

Transportation & Electronics

This business unit supplies manufacturers of transport vehicles and electronic equipment with products such as displays. Potential customers for these products include the automotive and aviation industries.

Health Care

In the health care segment, 3M offers medical technology of various kinds. These include dentistry and orthodontics products such as filling materials and components for braces. In food safety, products for quality and safety tests are sold. There are also numerous other product areas such as bandages.

Consumer

This segment includes all products that are directly aimed at the consumer. These include products for home renovation and office products.

The “Safety & Industrial” segment is the largest business unit and generates 34 percent of 3M’s revenues. It is closely followed by the “Transportation & Electronics” segment, which is responsible for 28 percent of sales. “Health Care and Consumer contribute 22 percent and 15 percent of sales respectively. 3M is very well diversified, as it offers many products from different business areas and no single segment or product accounts for too large a share of total sales.

How profitable is 3M?

Diversification has worked for 3M. In the chart below you can see the evolution of profits, cash flows and dividends per share. Because 3M generates its revenues from so many different areas, it is well protected against fluctuations in individual segments. This provides stability in earnings and provides shareholders with security. You can see this from the fact that 3M’s earnings per share have risen very steadily over the years and have not suffered any major setbacks. As you know, we at Dividendstocks.cash pay special attention to a long-term positive development without major fluctuations, because this ensures rising dividends for shareholders.

Share buybacks are also partly responsible for the increases. Like most other companies, 3M has used the low interest rate phase to exchange expensive equity for cheaper debt. In future, 3M will no longer have to pay the dividend for the repurchased shares. In general, lenders expect a lower return on their capital due to the lower risk. Therefore, debt is cheaper for 3M than equity in the form of stock.

Development of earnings and cash flows per share of 3M

Irrespective of buybacks, revenue has developed very well. This again emphasizes the stability of 3M’s business model. However, 3M is not immune to crises, as you can see from the drop in revenue during the financial crisis in 2008. But if you look at the forecast for this year, you can see that 3M should get through the Corona crisis much better than many other companies. That’s because 3M is able to offset the downturn in industrial demand, such as in the automotive industry, with revenue from other segments. The medical segment in particular is very stable because these products are always needed. In fact, the Covid-19 outbreak is likely to have greatly increased the need for protective equipment, which is means for money for 3M. The operating margin has also remained largely constant over the years. For the current financial year, only a small decline in margins is expected due to the pandemic.

Development of revenues and the operating margin of 3M

I also appreciate the fact all 4 major segments of 3M are equally profitable. With other companies you often see the problem that very profitable business units are “subsidized” by less profitable ones. This is not the case at 3M, as there are no big differences in margins between the segments. All business units contribute their share to the company’s success.

Are dividends safe?

As is typical for companies in the US, 3M pays its dividend on a quarterly basis. For the year, shareholders currently receive 5.82 USD, which represents a yield of 3.76 percent. This is already a respectable dividend yield, but you can also expect annual increases. 3M has been increasing its dividend for 62 years (!) without interruption.

3M Dividend History

To be able to pay a safe dividend and increase it regularly, a company must have stable cash flows. The free cash flow is the amount that remains after investments have been made. The free cash flow can then be used for dividends, share buybacks or debt repayment. 3M performs very well in this category. Over the last 20 years, free cash flow has been positive without exception, meaning that 3M generates a cash surplus every year. But that is not all. 3M’s capital discipline goes even further, because the so-called amortization power has also been positive in each of the last 20 years. It indicates how much of the free cash flow remains after dividend payments. You can see that 3M not only earns enough money to pay the dividend without any problems, but also has some left over at the end. In the lower chart you can see the amortization power as the green area.

Amortization power of 3M

This leaves 3M with some flexibility even after dividend payments and stock buybacks. The current cash balance on the balance sheet is sufficient to finance the dividend for over a year.

Are debts of 3M an issue?

Despite the strong cash flow, 3M’s debt has increased sharply in recent years. More precisely, it has doubled since 2014 and now stands at 36 billion USD. In the following chart you can see this increase in debt and the parallel increase in repurchased shares.

Development of debt and treasury stocks of 3M

Rising debt is usually not a positive aspect. However, I believe that 3M is not overindebted and that the debt does not pose a threat to the dividend. An important key figure is the coverage ratio. It is the ratio of operating profit to interest expense. It indicates how many times a company could pay the annual interest. Despite the increase in debt, the operating profit of 3M is 16 times (!) the size of the interest expense. There is therefore no realistic risk that 3M will not be able to service the interest. The interest payments only “consume” a small fraction of the profit, leaving enough for investments and dividends.

Is the 3M stock undervalued?

A high-quality company is always interesting. However, the stock becomes even more interesting if it is also attractively valued. The Dynamic Valuation on Dividendstocks.cash shows you the fair value estimates for the 3M stock. You can see that at the end of 2017/beginning of 2018, the share price has risen sharply without this rise being supported by fundamental data. The fair values were significantly below the price during this period. This means that the stock was overvalued. Since then, however, the stock has lost so much value that the current price is below the fair values.

Fair values for the 3M stock

Based on a P/E ratio of around 20, the 3M stock is still slightly undervalued, even when taking into account the declining profits in the current year. Since the 3M stock is a solid dividend payer, the fair value dividend is also interesting. Thanks to a historically exceptionally high dividend yield, the stock appears to be significantly undervalued from this perspective.

The overvaluation at the beginning of 2018 has turned into an undervaluation and once again it is clear that the stock market tends to exaggerate. I consider the price drop to the current level to be unjustified and view the 3M stock as an attractive buying opportunity at the current price.

Conclusion: 3M stock – at current price a buy

The 3M stock fulfils all criteria for a long-term investment. A safe dividend that is regularly increased and a solid business model that generates high profits through good margins. In addition, 3M generates positive cash flow every year, out of which the dividend can be financed without any problems. The cherry on top is the price which is cheap in my opinion. 3M is expected to generate good profits even during the Corona crisis. I think the stock is undervalued and see a good buying opportunity with an attractive dividend yield.