While 3M Company (NYSE:MMM) is one of the global leaders in the industrial sector, its financial performance has raised many concerns over the last decade and even more so recently. To add to this, litigation challenges and recent cash-demanding settlements worsen the mid-term outlook for the stock, leading to a Hold rating from analysts despite a quite inexpensive valuation. I am neutral on the stock as well.
A Time-Tested Business Model
Incorporated in 1929, 3M is slowly reaching its 100th anniversary and is, without a doubt, an iconic industrial conglomerate. The company divides its multi-faceted business into four operating segments.
The Safety and Industrial segment includes automotive parts, electrical, personal safety, adhesives and tapes, and other solutions. The Transportation and Electronics markets advanced materials and electronics, as well as transportation safety equipment, while the Healthcare segment offers oral care solutions, health information systems, and many more medical solutions. Finally, the Consumer segment provides products geared toward consumer health and safety, home care, and improvement.
Overall, the company maintains a well-diversified and balanced solutions portfolio. For 2022, 34% of sales originated from the Safety & Industrial segment, 26% from the Transportation & Electronics segment, and 25% and 15% from the Healthcare and Consumer segments, respectively. Most of 3M’s product offerings are rather indispensable and essential in their respective applications, making the company a more defensive option within the industrial sector.
In July 2022, 3M also shared its intention to spin off its Health Care business as a separate public company.
The Downhill Path for the Stock Continues
Between a broader stock market pullback, questionable financial performance, and some negative developments regarding the company, 3M’s stock has significantly underperformed over the trailing three-year period. While the S&P 500 (SPX) has seen a strong three-year total return of 45%, MMM has recorded a sharp 27.7% total decline, particularly materialized after the end of 2021. For more reference, the industrial sector has returned over 55% over the same period, as measured by the Industrial Select Sector SPDR Fund (NYSEARCA:XLI) ETF.
Currently, the stock pays a 5.88% dividend yield that has significantly increased as a result of its declining share price.
Concerning & Positive Financial Attributes
Over the past decade, 3M has barely seen any growth in sales, while the broader market and industrial sector have experienced strong growth and bull markets. MMM’s revenue has increased at a 1.0% compound annual growth rate (CAGR) over the past decade, while from 2022 to 2023, net sales have declined by -3.2%. Despite being negatively affected by currency translation, the +1.2% organic sales growth that the company reports is hardly desirable. For 2023, analysts see another decline in revenue.
One aspect of MMM’s business that appears very attractive is its profitability. The company records strong profitability metrics with gross margins of over 42%, operating margins of 19%, and net margins of 17%, all beating sector averages.
On a cash basis, MMM generated $5.59 billion in cash from operating activities in 2022. After deducting capital expenditures of $1.75 billion for the same year to reach free cash flow of $3.84 billion, more concerns arise — specifically regarding the company’s ability to pay dividends and continue share repurchases.
MMM spent $3.4 billion on dividends and $1.5 billion on share repurchases for 2022, which does not appear sustainable with the current cash-generating outlook for the business. 3M would either have to continue depleting its cash balance ($3.7 billion in 2022 compared to 4.6 billion in 2021) or raise more debt in order to sustain distributions to shareholders and buybacks.
Liquidity appears rather satisfactory (with a current ratio of 1.4x for 2022). However, working capital for 3M has decreased year-over-year from $6.4 billion in 2021 to $5.2 billion in 2023.
While the company’s leverage has significantly increased over the past decade, for the past couple of years, the total amount of long-term debt has not exceeded any alarming limits. Coupled with a declining stock price and broader investor uncertainty, however, leverage is hardly a strong point for the business.
Settlement with U.S. Public Water System Raises More Concerns
Earlier in June 2023, it was announced that MMM has reached a $10.3 billion agreement to resolve water pollution claims. The company is said to provide remediation funding over a 13-year period to cities, towns, and other public water systems, after facing multiple contamination lawsuits regarding its PFAS chemical products.
While the stock price had an initial positive reaction to the settlement, investors are set to take a very large charge, which comes as another negative sign for the business. Given 3M’s free cash flow generation, it is apparent that the settlement puts the company’s future dividends at somewhat of a risk. Especially when considering its large dividend yield and sizable long-term liabilities balance of $21 billion (approximately 36% of its market cap) that requires annual servicing.
On top of all that, other unresolved litigation claims from commercial entities and/or governmental bodies are likely to cause more financial hardship to MMM in the near and medium term.
Valuation Increases the Attractiveness of the Stock
As most can expect, given the troubling financial performance status of 3M, the company’s valuation appears rather reasonable. MMM trades at an 11.8x forward P/E multiple, 8.8x forward EV/EBITDA, and 1.8x price/sales. Even though these metrics fall below market and sector averages, they are still far from offering a bargain for the stock due to the uncertainty surrounding it.
Is MMM Stock a Buy According to Analysts?
Turning to Wall Street, MMM has a Hold consensus rating based on one Buy, eight Holds, and four Sell ratings assigned over the past three months. The average MMM stock price forecast of $106.31 represents 2.5% upside potential, with a high forecast of $159.00 and a low forecast of $92.00.
The Takeaway
After all things are considered, MMM seems to lack the financial performance attributes that would lead an investor to consider it a Buy at this point in time. As things stand, the company lacks growth, has high leverage, and faces litigation challenges. All these reasons, detailed in this analysis, lead to a cautious Hold rating from analysts and myself, even after considering the attractive current valuation of the company.
