Investors focused on long-term income are often drawn to Dividend Aristocrats, companies renowned for consistently paying dividends and increasing their dividend payouts annually for at least 25 consecutive years. In my earlier analyses, I highlighted six companies with an exceptional track records of boosting dividends annually for over 67 years. These include Dover (DOV, Financial), Procter & Gamble (PG, Financial), American States Water (AWR, Financial), Genuine Parts (GPC, Financial), Emerson Electric (EMR, Financial) and Parker-Hannifin (PH, Financial).
This anlaysis will explore another dividend aristocrat: 3M Co. (MMM, Financial). Remarkably, 3M has been paying dividends for over a century and has consistently raised its dividend payments for 66 consecutive years. Shareholders of 3M have enjoyed the combined benefits of sustained dividend growth and rising share prices over the years.
Business overview
The global diversified technology company operates across four primary business segments: Safety and Industrial, Transportation and Electronics, Health Care and Consumer. In 2022, the Safety and Industrial segment was the largest revenue generator, contributing $11.6 billion, which accounted for approximately 34% of the company's total sales. The Transportation and Electronics and Health Care segments followed closely, contributing $8.9 billion (26%) and $8.4 billion (24.6%), respectively, to total sales for the year. The Consumer segment, though smaller, still added a significant $5.3 billion, making up 15.5% of the total sales.
Interestingly, the Health Care segment is the most profitable, delivering the highest profit for 3M with over $1.8 billion in 2022, representing 36.2% of its total operating income. Thanks to its diverse 60,000 products and wide customer base, the company effectively mitigates customer concentration risk, ensuring a balanced and stable revenue stream.
The company's diversification strategy might be advantageous if a particular industry encounters difficulty. However, this approach could also reduce overall efficiency. Operating each segment as an independent company could potentially enhance the true value of each business unit. Recognizing this, 3M has decided to spin off its independent health care business into a new entity named Soventum in 2024. Following the spinoff, 3M will retain a 19.9% stake in the company.
Steady revenue and cash flow growth
Over the past two decades, 3M has consistently grown its revenue, starting from $16.33 billion in 2002 and reaching a peak of $35.35 billion in 2021 before slightly decreasing to $34.2 billion in 2022. This recent dip can be attributed to a combination of factors, including a sluggish global economy, a downturn in the disposable respirator industry and the exit from Russian business operations. Between 2002 and 2022, 3M's sales achieved a compounded annual growth rate of 3.8%.
Similarly, its operating cash flow has followed this upward trajectory, increasing from $3 billion in 2002 to $8.1 billion in 2020, then adjusting to $5.6 billion in 2022. The company's free cash flow mirrored this pattern, rising from $2.23 billion to $6.6 billion in 2020 before declining to $3.84 billion in 2022. Thus, the free cash flow's compounded annual growth has been nearly 2.8% in the past 20 years.
Adequate financial position despite high debt levels
Investors might express concerns regarding 3M's financial structure upon initial examination. As of September, the company reported a relatively modest $4.73 billion in shareholders' equity, contrasted with a substantial $16 billion in interest-bearing debt. However, this lower level of shareholders' equity is largely attributable to the company's extensive share repurchases over the years, totaling nearly $32.9 billion by the third quarter of 2023.
Over the past two decades, 3M's debt-to-equity ratio has varied from 0.24 to 2.11. In 2022, this ratio stood at 1.14, but it escalated to 3.58 in the most recent quarter. The company's interest coverage has been quite robust in the same period. Although it has decreased from a peak of 62.70 to 9.80, the current interest coverage level is still more than sufficient to manage its interest expenses effectively.
Attractive and growing dividend
3M's appeal to long-term income investors is largely due to its consistently increasing annual dividend payments. Since 2003, the company's dividend per share has grown from $1.32 to $5.96, illustrating a compounded annual growth rate of 7.83%. This steady increase has been complemented by 3M's conservative approach to its dividend payout ratio, which has remained within the range of 0.37 to 0.66. In 2022, this ratio was prudently maintained at just 0.59, underscoring the company's safety and stability to keep raising dividends in the future.
Significant upside
The Gordon Growth Model, an ideal framework for companies demonstrating steady dividend growth, is highly applicable to 3M given its impressive track record of 66 years of consistent dividend increases. If we assume that 3M sustains a somewhat reduced dividend growth rate of 7% and use a discount rate of 10%, the intrinsic value of the stock can be determined as follows:
P = Expected Dividend for 2023 / (Required Rate of Return - Dividend Growth Rate)
= $5.96 *(1+7%) / (10%-7%)
= $213
Applying the Gordon Growth Model, 3M's intrinsic value is estimated to be approximately $213 per share. This valuation is notably 100% higher than its current share price.
Key takeaway
3M stands out as a sterling example of a Dividend Aristocrat, appealing to long-term income investors with its consistent history of dividend growth and strong financial performance. The company's diversified operations across various sectors have contributed to a steady revenue stream and ensured profitability even in challenging market conditions.
Despite some short-term dips in revenue and cash flow, 3M's long-term financial health remains robust, supported by a conservative dividend payout ratio and a solid balance sheet. The application of the Gordon Growth Model underscores the company's potential undervaluation in the market, suggesting a potential 100% upside for investors. In essence, 3M's blend of resilience, consistent dividend growth and future growth prospects makes it a compelling choice for those seeking reliable long-term investment opportunities.
