3M Company - A Slightly Expensive Dividend King

In this brief May 21, 2020 article, I analyze and disclose a new position in 3M Company (MMM) for our daughter's taxable account. I subsequently analyze and disclose in this November 4, 2020 article the purchase of additional shares for that account. In both instances, I conclude MMM shares are undervalued. Fast forward to the April 27, 2021 release of Q1 2021 results and FY2021 guidance. Shares are now trading well over my May and November 2020 purchase prices. At first blush, it looks like 3M Company is a slightly expensive Dividend King. Let's have a closer look.

A Dividend King is a company that has increased its dividend for at least 50 consecutive years. MMM certainly meets this criterion!

Even though MMM has an envious dividend track record, investors should look at an investment from an overall potential return aspect and not just the dividend yield.

Business Overview

I always recommend an investor have a basic understanding of a business before initiating a position. A great source of information is the company's 10-K. The first section of MMM's 10-K includes a review of the company. An explanation of various Risk Factors follows the company review.

MMM also provides an Investor Overview on its website.

Further information is found in the 2018 Investor Day 2019 –2023 Plan Financial Review.

Financial Review - Q1 2021 Results and FY2021 Guidance

MMM's Q1 results and accompanying Earnings Presentation have been released on April 27, 2021.

Risk Assessment

Moody's continues to assign an A1 rating to MMM's long-term domestic unsecured debt. S&P Global continues to assign an A+ rating. Both ratings are the top tier of the upper-medium level within the investment-grade group of ratings. The creditworthiness of these ratings defines an obligor as having a STRONG capacity to meet its financial commitments. The obligor, however, is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

MMM's credit risk is acceptable from my perspective.

Dividend and Dividend Yield

After my November 4, 2020 article, MMM increased its quarterly dividend from $1.47 to $1.48 commencing with the March 12, 2021 dividend; MMM's dividend history can be accessed here. This is a 0.7% increase which certainly does not appeal to investors seeking to generate a stream of dividend income where growth outpaces the rate of inflation.

At the time of my November article, I was anticipating a ~3% dividend increase. This would have matched the prior $1.44 to $1.47/share/quarter increase.

When my daughter acquired shares on May 21, 2020, and November 4, 2020, MMM's dividend yield was ~4% and ~3.63% respectively.

With shares currently trading at ~$194.50 and the quarterly dividend being $1.48, the forward dividend yield is ~3.04%.

The MMM shares held in our retirement accounts do not incur a 15% dividend withholding tax. Those held in our daughter's taxable account and an account included in the FFJ Portfolio incur the withholding tax. This reduces our dividend yield to ~2.6%!

Share Repurchases

MMM deployed $0.231B of its ~$1.4B of Q1 Free Cash Flow toward share repurchases. Despite this, the diluted weighted average common shares outstanding in Q1 is 586.3 million versus 582.2 million in FY2020.

For comparison purposes, MMM’s 2010 – 2020 diluted weighted average common shares outstanding amount to 726, 719, 703, 694, 662, 637, 619, 613, 602, 585, and 582.

MMM generates significant Free Cash Flow and I think sufficient shares will be repurchased in the remaining 3 quarters of the current fiscal year to keep intact the trend in the reduction of diluted weighted average common shares outstanding. Having said this, I do not wish to have MMM repurchase shares simply to keep its track record intact. I would much rather it repurchase shares when the valuation supports the same.

Valuation

At the time of my May 21, 2020 article, MMM had withdrawn FY2020 guidance. For the sake of determining MMM's valuation, I used a conservative $2.05/quarter EPS over the remaining 3 quarters in FY2020; it generated $2.22 in Q1 2020. On this basis, I expected MMM to generate $8.37 for FY2020.

Shares were trading at ~$146.26 so using my FY2020 diluted EPS estimate, I arrived at a ~17.48 forward PE.

When I wrote my November 4, 2020 article, MMM had generated diluted EPS of $6.87 for the first 3 quarters and I estimated MMM would generate ~$9.30 diluted EPS in FY2020.

I acquired additional MMM shares at ~$162 on November 4, 2020, so using my FY2020 diluted EPS estimate, I arrived at a ~17.4 forwards PE.

MMM ended up generating $9.25 diluted EPS for FY2020. On this basis, the PE for the shares purchased in May is ~15.8 and ~17.5 for the shares purchased in November.

Looking at the Q1 2021 results released April 27, 2021, we see diluted EPS of $2.77 in Q1. FY2021 adjusted EPS guidance remains in the $9.20 - $9.70 per share range.

If we FY2021 GAAP and adjusted EPS end up being identical and we use the current ~$194.50 share price, we get a forward adjusted diluted PE range of ~20.1 - ~21.2.

For comparison purposes, MMM’s 2010 – 2020 PE levels are 15.33, 13.90, 14.69, 21.54, 22.54, 19.46, 22.49, 26.27, 25.54, 20.93, and 20.49.

When MMM's PE was 26.27 in 2017 I wrote I Applaud J.P. Morgan Analyst For Downgrading 3M in October 2017 after the 'Sell’ call in September 2017. Many investors expressed their displeasure on blogs and message boards. I, however, totally agreed with this call.

I do not think MMM is as richly valued as when the JP Morgan analysts initiated the 'Sell' call but think the current valuation is a bit rich.

3M Company - A Slightly Expensive Dividend King - Final Thoughts

I compare MMM's results to May and November 2020 when I acquired shares and see no justification for an increase in the company's valuation. Perhaps the higher valuation is because there is a considerable amount of money 'sloshing around' the system. We also have unprecedented Debit Balances in Customers' Securities Margin Accounts. Furthermore, investors have put more money into stocks in the last 5 months than the previous 12 years combined.

The simple law of economics dictates prices will rise when supply (liquidity) exceeds demand (high-quality investment opportunities).

There are various ways in which the equilibrium can be restored. The challenge, however, is that we have no idea when this will occur.

For now, I am paying heed to Charlie Munger's advice on how to become a better investor and am being patient and disciplined. I am in no hurry to acquire additional MMM shares.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom.

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long MMM.

Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.