I absolutely love investing in some of the great industrial titans.
These investments seem like no-brainers to me, and that’s because investing in just one great, diversified industrial company exposes you to almost every facet of the economy.
Investing in a high-quality and broadly-diversified industrial giant can be like investing in a fund, rather than simply a lone company.
And one particular industrial company out there has its fingers in so many pots, it’s difficult to describe them all in one article.
That time frame stretches across multiple wars, economic recessions, massive inflation in the ’80s, 9/11, numerous stock market crashes, and even the more recent financial crisis.
Yet, 3M Co. (MMM) kept on pumping out increasing dividends to shareholders.
And you’ve gotta like the odds that they’ll keep doing that for another 60 years… and beyond.
I’ll explain why.
3M is a global, diversified industrial company.
They operate in five segments: Industrial (33% of fiscal year 2016 revenue); Safety & Graphics (19%); Healthcare (18%); Electronics & Energy (16%); and Consumer (14%).
It’s funny that 3M Co. is probably known to most consumers as “that company that makes Post-it notes”, but you can obviously see just by looking at their segments that they’re much more than that.
This is a company that operates across more than 70 countries worldwide and derives approximately 2/3 of its revenue from outside the US, all while employing 90,000 people.
It has a market cap of $145 billion.
So, yes, we’re talking about more than office supplies.
Just to give you an idea of some of the various products they manufacture and provide, think personal protective equipment, protective duct wraps, structural steel fireproofing, adhesives, abrasives, thermal insulation, filtration products, advanced ceramics, advanced films, and graphics.
I could literally fill 10 paragraphs with all of the products and solutions they offer, but you get the gist.
By investing in 3M Co., you’re basically exposing yourself to a broad cross-section of the entire global economy.
Now, it should go without saying that you don’t build a track record of 60 consecutive years of dividend raises to shareholders without doing something right – and that something right is increasing profitability like clockwork.
So let’s take a look at their top-line and bottom-line growth over the last decade, before moving on to some other fundamentals. Their fiscal year ends December 31.
Revenue grew from $24.462 billion in fiscal year 2007 to $30.109 billion in FY 2016. That’s a compound annual growth rate of 2.33% over that time frame.
A bit disappointing here, as I’d usually expect something closer to mid-single-digit top-line growth for a large, mature, global company like this. That said, business never operates in a vacuum. there have been a number of divestments made over the last few years, all of which have impacted sales.
Meanwhile, earnings per share increased from $5.60 to $8.16 during this period, which is a CAGR of 4.27%.
The excess bottom-line growth was driven by share buybacks which reduced the outstanding share count by approximately 15% over the last 10 years.
CFRA is calling for 3M Co. to compound its EPS at a 12% annual rate over the next three years, believing that improved global economic demand, continued buybacks, the introduction of new products, volume increases, and productivity enhancements all bode well for the company.
But what about that dividend?
Well, I already let the secret out that the company has been increasing its dividend for almost six decades straight.
That kind of record means they’re a “Champion” on David Fish’s illustrious Dividend Champions, Contenders, and Challengers list.
However, 3M Co. isn’t handing out tiny dividend increases simply to keep their incredible dividend growth streak intact.
Over the last decade, they’ve increased their dividend by annual rate of 9.4%.
That kind of dividend growth looks a bit too aggressive in light of the EPS growth over the same time period, but an acceleration of bottom-line growth (as laid out above) could serve to underpin continued high-single-digit dividend growth for the foreseeable future.
And the dividend is supported by a very reasonable payout ratio of 52.4%, which means the company is returning just over half its EPS to shareholders in the form of a dividend; the other portion of EPS is being retained by the company.
This is a healthy mix that’s very close to what I consider to be a perfect balance between paying dividends and retaining earnings (i.e., a 50% payout ratio).
It gets better: Thanks to the stock’s recent pullback, it now yields 2.4% — which is about 10 basis points higher than its own five-year average.
The company’s balance sheet is incredibly conservative, which tends to be a hallmark of a blue-chip company.
While the long-term debt/equity ratio of 1.04 looks quite high, this is artificially inflate due to low shareholders’ equity.
However, the interest coverage ratio is over 36, which is rather incredible.
3M Co. has managed respectable growth – growth which could very well accelerate from here – even without the use of a lot of leverage, which positions them well in an environment in which rates are now rising.
Looking at profitability, the company posts some very robust numbers every year.
Net margin has averaged 15.65% annually over the last five years, while return on equity averaged 34.15% annually over that same time frame.
There’s been some margin expansion lately, while ROE is as high as it is even without a lot of leverage.
3M Co. is among the leading manufacturers of products for many of the markets it serves, and their size and scale provides them unique competitive advantages.
Their expertise is another advantage, of which their sizable R&D budget – they spent more than $1.7 billion on research and development over the course of 2016 – continues to provide them a great source of innovation and a well-developed product pipeline.
Although their Consumer segment is only 14% of revenue, this is where some of their more notable and recognizable brands come to light. Brands like Post-it, Scotch, Scotch-Brite, ScotchBlue, Scotchgard, Filtrete, Command, Ace, Nexcare, and the eponymous 3M.
But their diversification across products and markets is really a key aspect to the business.
They have exposure to electronics through touch screen films; data centers through engineered cooling fluid; healthcare through drug delivery solutions; manufacturing through adhesives and abrasives; the home through filtration and cleaning products; the workplace through office supplies; and transportation through reflective tape and raised markers.
There’s a lot to like about 3M; however, one should weigh the risks.
Primarily, there is competition to worry about in the industrial space.
Furthermore, the global economy might slow down in unforeseen ways. Even the mighty 3M Co. saw its net income drop during 2008 and 2009 (although the dividend kept on rising).
In addition, there is risk that the product pipeline won’t yield new products that can spur continued growth for the company.
Overall, I see 3M’s risk profile as quite low.
The big issue, though, might be valuation.
The stock is trading hands for a P/E ratio of 28.4 right now, which is a significant premium to the stock’s own five-year average P/E ratio of 21.3. Plus, that’s a massive premium shares are commanding relative to the broader market.
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a 7.5% long-term dividend growth rate.
That DGR is on the higher end of what I normally allow for, but I think 3M Co.’s fundamentals, competitive advantages, and track record all allow for the benefit of the doubt.
A near-perfect payout ratio and the possibility of accelerating earnings could even allow for some upside to this, but that’s balanced against disappointing bottom-line growth over the last decade and a most recent dividend increase that was below 6%.
The DDM analysis gives me a fair value of $202.10.
So even with its recent pullback, the stock looks expensive against the current price of ~$229.
Bottom line: 3M Co. (MMM) is a global industrial powerhouse that’s diversified across a multitude of products, markets, and geographies. The dividend growth history is remarkable, and the company is poised to continue that streak well into the future. However, the stock looks pricey right now. Waiting for a further pullback seems prudent, although the company’s quality, low-risk profile, and impressive history means the stock may trade at a premium to the market and its own recent historical valuation for some time.
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