There are a lot of variables that make a company successful. There are thousands of publicly traded companies available for investors to choose from. When we talk about true “blue chip” companies, for some reason the fact that they may be a household name can deter investors, when in reality it may be wiser to simply appreciate the greatness of a particular organization. Sometimes, boring is better. Today’s spotlight article hones in on one such company, 3M Company (MMM). 3M has raised its dividend for a staggering 60 consecutive years (and counting), and still continues to grow thanks to getting a high return on capital and strong cash flow generation. Let’s dive into what makes this company such a well oiled wealth building machine.
Success From Casting A Wide Net
3M Company is an industrial conglomerate that manufactures and distributes products across the world in various industries. Everything from safety materials, to health care products, to sticky notes, 3M is present throughout today’s world. The company currently separates itself into five business segments (below).
source: 3M Company
source: 3M Company
Much like how diversification of investments can protect investors from risk, the same can be said about a company’s revenue streams. 3M is extremely diversified across many industries. Because of this, its risk is very low that an industry specific event would greatly hamper 3M’s top or bottom lines.
In fact, the only thing to have a drastic impact on the company’s performance are systematic declines from recessions. Even then, the great recession of 2008-2009 is merely a downward blip in the grand scheme of things.
This type of consistent growth has enabled 3M to raise its dividend for 60 consecutive years. Over the past 10 years, the dividend CAGR has been an impressive 9.4%. That is a lot considering the company has raised its dividend for 50 years up to that point. Despite the mature status of 3M, it continues to find growth. How does 3M accomplish this?
3M is probably most known by typical households as the makers of sticks notes. However, 3M is actually one of the most innovative companies in the world. They have a huge R&D budget, which provides more than 3,000 new product patents per year. Altogether, 3M invests 5.8% of its revenues back into the company to develop new technologies and products.
If you are a casual reader of my content, you will recognize this generalization when I say that cash flows are the “life blood” of a company. Cash ultimately pays the dividend, and cash ultimately fuels organic growth of a company. That is why I put a huge emphasis on companies that A) convert a high percentage of their revenues into free cash flow, and B) are receiving a strong cash return when they invest capital back into the company.
This graph is a thing of beauty, and represents the long term excellence that 3M has maintained. To put it in perspective, I tend to look for a company to convert 10% or more of its revenues into free cash flow. At that point, a company has the type of cash generation that gives it a lot of financial flexibility (to pay dividends, reinvest for growth etc). In regards to CROCI, I look for companies that perform at the low teens or higher. 3M’s 20% cash return on capital is an excellent indicator that the company is making wise decisions with where it invests its cash.
Growth From Bringing The World Solutions
Growth is obviously very important for the future success of a mature company such as 3M, and their track record of achieving it is noted as well. But how will 3M continue to grow? If I had to sum it up in one word, I would say “leadership”. Leading the market has long been a 3M strategy.
How does 3M lead the market? By bringing cutting edge solutions to market at a global scale.
3M brings solutions to problems worldwide. Despite being a US company, only 39% of revenues are generated in the United States. 3M is focused on providing solutions to a number of problems and developing new technologies throughout the market.
Electric cars are projected to grow substantially over the coming decades. It is estimated that by 2022, electric vehicles will have similar production costs as traditional internal-combustion vehicles. This could spike demand as our world moves to greener energy sources. 3M designs and produces various components that go into these electric cars such as those used to build batteries, insulation, and weight reduction features.
Pollution is a growing concern in various emerging markets such as China, India, and Africa. 3M develops filtration and treatment systems for air and water at both the individual level, as well as industrial. Side note: ironically 3M just paid out a cool $850M to the state of Minnesota for a pollution law suit. The company improperly disposed of chemicals which contaminated drinking water, and other aspects of the environment.
A final major growth driver moving forward for 3M will be healthcare. Healthcare spending is continually rising, and is growing even more rapidly in emerging markets.
3M plays an under the radar, but important role in this field. 3M’s wide healthcare presence spans from dental crowns, to bandages, to sanitation and wound care. 3M’s healthcare presence spans thousands of items and will benefit from industry wide growth in the years to come.
Through 2020, management has forecasted organic revenue growth of 2-5% annually, and targeted EPS growth of between 8-11% per annum. The new CEO of 3M Mike Roman has recently stated that the company could see some acquisitions and divestments of assets to reshape the company for stronger growth opportunities. These developments will be important to monitor moving forward.
Even for a high quality blue chip company such as 3M, valuation still plays an important role in the investment process. Shares of 3M are currently about $6 off of 52 week lows.
Coming all the way down from near $260 per share at the beginning of the year, the stock had gotten a bit too hot. 3M is expecting to earn approximately $10.50 per share this year, thus the earnings multiple has fallen from almost 25X 2018 earnings to almost 19X earnings. This is still higher than the decade long average of 17X earnings. Meanwhile from an income perspective, the dividend’s current yield of 2.70% is a little bit higher than its decade average of 2.45%.
I also like to look at free cash flow yield as a guide of value.
An important thing to remember when valuing a stock is to take into account how one time items can impact your numbers. The cash flow yield is terrible in part because free cash flows were hit by a $897M expenditure for the settlement I referenced earlier in the article. If I add that back into the cash flow figures, the true cash flow yield on today’s share price is more like 4.1%. Even after we adjust this number, the cash flow yield is still lower than it was as recently as 2016.
Will a stock already near 52 week lows continue to decline? This would be a great time to have a crystal ball! What I do know is that 3M is pretty consistent with steady, upward growth. With that said, 3M is also an industrial company in the midst of a very hot economy. Any type of economic downturn would certainly put downward pressure on the stock. The stock has fallen enough from its highs that 19X earnings isn’t a terrible valuation to pay for a truly fantastic company such as 3M.
Companies such as 3M are truly special. Not only is it difficult to find a company with 60 years of consecutive dividend increases, but the emphasis on new technology and solutions gives it a growth trajectory moving into the future. 3M is a robust cash generator, and receives excellent returns on the cash that it puts back into the business. With such a widespread presence in so many industries, it can be certain that 3M will play a part in solving the world’s industrial challenges both today, and tomorrow.
As a trader, you may see shares of 3M waffle sideways for a while. The company has certainly been a roller coaster as of late, and Mike Roman’s comments about the need to potentially shuffle assets may move the price one way or another. If you take the long term investment approach (as I do because that is my personal strategy), you will do alright in the long term here. The stock is a touch over-valued by historical standards. However, 3M is the type of consistent, steady wealth creator that works out if you just buy it at a fair value and hold it for long periods of time.
source: Dividend Channel
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.