Without considering where interest rates are heading beyond the next year or two, 3M has increased its debt and therefore its annual debt servicing costs, assuming no change in the average weighted interest rates or in borrowing terms. 3M already has targeted lowering its stock buyback plans to help pay for the Acelity buyout, and it is crossing paths where 3M may have been too confident in its dividend hikes to get its static dividend liability up to over $3.3 billion.
One thing that may keep this dividend and future hikes safe at the board level is common sense. 3M’s board of directors almost certainly knows that ending a 61-year dividend hike, even if that streak gets to 65 years or 70 years, would be received terribly by shareholders. Shareholders love dividend hikes, and they hate dividend cuts. 3M needs to be committed to perpetual dividend hikes if the laws of numbers will allow for it.
Another issue on valuations now and looking ahead is that 3M has unpredictable earnings with a series of earnings disappointments, as 3M’s 2018 earnings was $10.46 per share. Most analysts have become skittish and are not willing to commit to exactly when 3M’s big turnaround will come.
According to Morningstar, 3M’s forward price-to-earnings ratio is 17.83. Refinitiv has 3M valued at 18.5 times expected 2019 earnings and 17 times expected 2020 earnings. Those are not shockingly expensive, but for a company with unpredictable earnings, it is also not exactly cheap.
3M may be a partial victim of its own success before the last management succession. In 2018, 3M announced that Michael Roman would replace Inge Thulin as chief executive officer. Thulin had been 3M’s CEO and president since 2012, and he was then set to become executive board chair after his mid-2018 succession.
At the start of 2018, 3M had blown the doors off of its 2017 expectations from analysts with a gain of more than 31% (versus a mere 6% expected gain at the start of 2017). At the start of 2018, its shares were already valued at more than 5% higher than the Refinitiv consensus price target at the time, and 2018 was when 3M’s fundamental problems met its valuation problem. Unadjusted for dividends since then, 3M’s 2017 year-end price was $235.37 — versus about $174.50 at the current time.
One issue that has become more prominent in recent months is an environmental exposure tied to polyfluoroalkyl substances (PFAS). This has exposure via personal injury liabilities and groundwater cleanup costs. That exposure is still not fully known, but a report from Merrill Lynch recently noted that 3M’s individual portion of approximately $18 billion in pretax liabilities could be about half of the total. This total dollar amount is still not fully known, and the situation could take years to settle before the full extent of the liability is determined. If the outcome ends up being in the billions of dollars, will 3M then have to take on even more debt or will it be able to fund a pool and pay over time? Either way, liabilities from the past that are no longer really contributing to earnings and revenues likely will contribute to the future liabilities, and it is impossible to quantify what that price tag may be.
Merrill has a Neutral rating and $185 price objective on 3M. Its updated analysis conservatively incorporates a higher number of contaminated sites, while its initial base case only considered sites that had already filed suit. The firm believes that 3M has sufficient financial resources to meet future obligations and that the current share price already reflects investor concerns around PFAS. Its Neutral rating reflects limited near-term execution visibility and PFAS liability, but they meet what has been called a best-in-class global franchise and solid balance sheet. There is still the issue about what is driving margins lower and there is no solid plan on how and when 3M can get its margin expansion back on track.