Is 3M Still a Good Choice for Dividend-Seekers?

Joshua Aguilar: Wide-moat-rated 3M is one of five diversified industrial firms that has consistently paid an annually increasing dividend for over 60 years. The stock currently trades at a slight 10% discount to our fair value and pays a solid forward dividend yield of 3.1%. We'd be buyers of the stock at our 5-star price of just below $150 per share.

We believe the market has overreacted to two key variables: 1) 3M's latest guidance cut; and 2) 3M's potential PFAS litigation exposure. Since Mike Roman has been at the helm for nearly a year, 3M has been forced to cut guidance on five different occasions. That said, 3M consists of short-cycle businesses that are notoriously hard to predict. Most of the slowdown has come from three distinct end markets which make up over 30% of its revenue base, which include automotive, electronics, and China. And the company simply missed reacting to slowing demand.

Even so, 3M has a very flexible installed manufacturing base, and they're able to retool their operations to offset some of the slowdown in demand. More importantly, we still believe 3M has a portfolio that can grow at GDP-plus, primarily from their healthcare and safety businesses. 3M's healthcare portfolio is exposed to a number of strong secular trends, including an aging baby boomer population, rising incidents of chronic disease such as diabetes and asthma, a growing number of surgical procedures, as well as demand for efficient management of large volumes of medical data. From a strategic standpoint, the acquisitions of MModal and Acelity position 3M's healthcare portfolio to capitalize on these trends over the longer term. 3M's safety portfolio is really another area we're expecting outsize, GDP-plus growth from, driven by the need to replace aging infrastructure and increased urbanization in the developing world from rural areas.

PFAS litigation is another area we're closely watching from 3M. PFAS are a family of man-made fluorinated organic chemicals which been used since the 1950s. These are strong molecular bonds that simply don't break down easily in nature. But 3M phased out most of these compounds in 2002, with the remainder phased out in 2009. That said, these compounds have now been found in our water supply. So, 3M already booked a reserve of about $230 million related to its manufacturing liability in five sites--three in the United States and two in Europe. However, this reserve doesn't cover product liability. So, while the market fears this exposure could total tens of billions of dollars, we estimate that the cost of the liability could total about $3.4 billion, which we model into our explicit forecast.

Even so, we don't believe that exposure threatens 3M's ability to pay its dividend, though the acquisition of Acelity does mean 3M would have to shut off its buyback spigot in a 25% bear-case probability scenario. In sum, we believe 3M's culture of innovation that allows it to create value-additive products that sell at a 15% premium to the rest of the market remains intact.