Published Jan. 21 by Bob Ciura
3M (MMM, Financial) is one of the rare dividend stocks you can set your watch to. The company delivers a dividend increase each year in February like clockwork.
Last year’s increase was a doozy—the company raised its dividend by 8% and also announced a $10 billion share repurchase.
3M has raised its dividend for 58 years in a row. It is a Dividend Aristocrat, which are an elite group of companies in the S&P 500 that have raised their dividends for 25+ consecutive years.
3M has maintained such a long history of dividend increases and share buybacks because the company has a strong brand, a highly profitable business model and generates billions of dollars in cash flow each year.
This article will discuss why 3M is a virtual lock to raise its dividend in a matter of weeks.
Business overview
3M is a diversified industrial giant. Most investors probably know the company from its popular consumer products brands, including Post-It-Notes and Scotch tape.
But 3M has a huge product portfolio. The company services virtually every industry. It operates five segments, each of which generates more than $4 billion in annual revenue:
- Industrial (33% of revenue).
- Safety & Graphics (19% of revenue).
- Health care (17% of revenue).
- Electronics & Energy (16% of revenue).
- Consumer (15% of revenue).
All of these businesses are large, and all are highly profitable. Each segment generates an operating margin of 21% or higher.
It achieves such high margins because of its competitive advantages. 3M has a robust portfolio that is filled with strong brands, thanks to its industry-leading research and development.
Source: 2017 Outlook Meeting presentation, page 17
3M’s R&D is second to none in the industrial sector. Its R&D spending reached nearly $2 billion in 2015.
Among its operating segments, safety and graphics, health care, and consumer product sales are growing nicely for the company. 3M’s safety and graphics business posted a 9.5% revenue increase over the first nine months of 2016.
Its health care and consumer segments grew revenue by 5% each in the same period.
This growth helped offset a 17% decline in energy revenue through the same period, driven by falling commodity prices and lower capital investment from 3M’s oil and gas customers.
Business conditions for 3M remain challenged, particularly in the oil and gas segment. And, revenue growth is under pressure from the strong U.S. dollar, which makes exports less competitive.
But more broadly, conditions are still supportive of growth. Overall, 3M’s operating profit rose 2% through the first three quarters of 2016. In 2017, the company hopes to accelerate growth.
Growth prospects
There are two significant growth catalysts for 3M in 2017 and beyond. These are international growth, particularly in the emerging markets, and cost reductions.
Growth in international regions really helped 3M in 2016. For example, 3M’s organic revenue—which excludes currency fluctuations—increased 3.4% in Latin America and Canada through the first nine months of 2016.
Separately, organic revenue increased 1.2% in the company’s Europe, Middle East and Africa segment.
At the same time, revenue declined 0.3% in the U.S. in the same period.
Continued growth in emerging markets will be a key driver for 3M moving forward, as the company generates nearly half of its U.S. sales from outside the U.S.
Looking back, cost reductions have fueled 3M’s growth for an extended period. The company launched a Six-Sigma initiative to streamline its manufacturing processes in 2001.
Since the program’s inception, the company has generated more than $16 billion in cumulative savings. These savings can then be passed on to investors through annual dividend increases and billions in share buybacks.
Going forward, 3M is undergoing a major restructuring, designed to reduce costs by driving efficiency. This initiative is bearing fruit. 3M expects to generate $500 million to $700 million in annualized savings starting next year, along with $500 million in working capital improvements by 2020.
Thanks to the combination of organic growth and cost cuts, 3M expects to generate 8% to 10% annualized earnings-per-share growth through 2020.
Source: Goldman Sachs Industrials Conference, page 7
This will provide more than enough growth necessary to continue the company’s impressive dividend growth streak.
Dividend analysis
One of the most attractive aspects of 3M stock is its capital returns. The company has a shareholder-friendly management that is committed to returning cash to investors, through dividends and buybacks.
Source: Goldman Sachs Industrials Conference, page 6
3M’s current dividend is well-covered by the company’s profits. Over the past 12 months, 3M posted EPS of $7.84; its current dividend is $4.44 per share.
With a trailing payout ratio of 57% and an outlook for growth, 3M should be able to match its 2016 dividend increase, or come close to it.
For example, if the company were to raise its dividend by 8% to 10%, its forward dividend rate would rise to $4.80 to $4.88 per share. This would still be well below its earnings.
Analysts expect 3M to increase EPS by 7.9% in 2017. This would provide enough room for the company to at least match its 2016 dividend raise, and keep the payout ratio essentially unchanged.
An 8% to 10% increase would elevate its forward dividend yield to 2.6% to 2.7%. At that level, it would still provide an above-average dividend yield. The S&P 500 has a 2% average dividend yield.
Final thoughts
3M is a rock-solid dividend stock. 2016 marked the 100th year of paying dividends to shareholders. No company can pay uninterrupted dividends for a century without a durable brand and long-lasting competitive advantages.
3M is no exception. It has navigated recessions, wars and all sorts of geopolitical conflicts over the past several decades. It proven the ability to stand the test of time.
The company could approach 2017 with a bit of caution, given the weak global economic growth, strong U.S. dollar and heightened level of uncertainty.
Still, an 8% to 10% dividend increase isn’t out of the question, given the company’s excellent financial position.
The company should provide another dividend increase that significantly exceeds inflation. As a result, investors should continue to view 3M favorably as a dividend growth stock.
Disclosure: I am not long any of the stocks mentioned in this article.
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