Why 3M Will Continue To Outperform

Saturday, January 11, 2014

Why 3M Will Continue To Outperform

3M Co. (NYSE:MMM), which is a, highly diversified company producing industrial products ranging from adhesives and abrasives to electronic circuits and optical films recently stunned the Wall Street by declaring a 35% increase in dividend along with massive share buyback plan. This naturally caused the 3M's stock to grow rapidly. 
Image credit: birdigol / 123RF Stock Photo

The dividend hike also raised questions as to how the management could have declared such a massive rise on the back of steady but rather modest growth in the first three quarters of 2013. However, as we shall see below, the company's balance sheet and its own guidelines for 2014 provide some justification for management's enthusiasm.
3M's recent announcements
3M has been paying a dividend to shareholders for 97 years and has been raising the dividend steadily for 50+ years. It is necessary to note, however that its competitors Emerson Electric (NYSE:EMR) and Dover (NYSE:DOV) have also been increasing dividends for 56 and 57 years respectively. However, their latest raises (the 57th and 58th respectively) were of the order of 5% and 7%. On the other hand, CEO Inge Thulin led 3M to announcing a 35% increase in dividend to $3.20. This can be compared to a dividend raise of 8% by 3M last year.
The company has declared that it will spend between $17 and $22 billion in share buybacks over the next few years (2013-17). This is also significantly higher when compared to its earlier estimates of $7.5 to $15 billion. Such enthusiasm has surprised many analysts since the industrial giants are known to have highly diversified business models which allow for steady but rather unremarkable growth. 3M's organic growth for the first three quarters of 2013 has followed this slow and steady mode with diluted EPS and sales both growing by 3% in the period.
The story of the balance sheet
It is evident that the growth figures of the past provide little explanation for the company's prodigious dividend increase. Firstly, the company has about $5.8 billion in debt, which is not terribly high for a company of this size, especially if one considers the $3.3 billion that 3M has in cash and short term equivalents. The company's cash on hand has almost doubled compared to the Recession troughs of around $1.8 billion.
The company's payout ratio is not excessively high, even after the dividend raise. As of now it has a trailing payout of 52%. Additionally, the company has been buying back shares already with the current outstanding share count being 673 million as compared to the five year high of 715 million. These together indicate that the company has a decent balance sheet which will improve further in the coming years.
The road ahead for 3M
Whereas the previous head of 3M had kept up a healthy growth rate through acquisitions, Thuln invested in R&D which leads to delayed growth. However, this growth is now starting to show, and it is expected that organic growth rate will be between 4% to 6% for the next four years. The company states that it expects earnings to grow by 3% to 6% in 2014, and rise by 10%. Further, EPS for 2014 according to 3M should be in the range of $7.30 to $7.55, which is broadly in line with analysts' estimates of $7.40 on revenue of $32.63 billion. As such, the rise of dividend to $0.85 cents per share does not represent a significant change in the payout ratio.
What about the downsides?
No company is without any potential downsides. 3M is currently subject to risk factors pertaining to worldwide economic conditions, its ability to maintain its credit and borrowing strategies, and competition and public perception of new products. Since 3M operates in over 70 countries worldwide, it’s subject to a vast number of different social, political and economic factors that could potentially harm its business.
Since 3M currently has an AA- credit rating from S&P, it is able to procure financing at lower costs. The maintenance of this credit rating is crucial to its ability to continue to borrow.
Of course, the public must continue to favor 3M's products and respond positively to new ones, in order for the company to continue to perform.
Many of these downsides are constant across any company, which means that the positives for 3M will outweigh any negatives. It should result in a more positive future for 3M.
The investor's decision
The fact that 3M has done something unique by raising its dividend by 35% and announcing a massive buyback program cannot be overlooked. However, it is equally unprofitable to seek evidence in the company's balance sheet or future growth possibilities which will convincingly prove that the management's optimism is unfounded. In all likelihood, the company will continue expanding. Though another massive raise may not be in the offing in the short term, further dividend raises are a distinct possibility given the company's long history of regular dividend increases. These factors make the company a definite "buy" for both existing shareholders of the company as well as those seeking a stable stock with consistent dividend growth.
Author: Justin Martin

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