3M, which has been hit by the market, is undergoing major changes, including divesting its healthcare division and resolving litigation issues, making it a more flexible company.
For a long time, 3M (MMM.N) looked like it was pieced together with Scotch tape. However, after a series of recent moves, the company seems to have grown more resilient.
3M, which produces a series of sticky products such as sticky notes, has experienced many difficulties in recent years. Legal issues relating to “permanent chemicals” polluting water sources and selling potentially defective earbuds to the government have dragged down the company's stock price. The company's other businesses — including adhesives for electronics, advanced materials for automobiles, and reflective tape — are also facing difficulties, leading to stagnant growth and narrow profit margins. Over the past five years, 3M's stock price has dropped 34%, and by the end of 2023, many investors thought it had little investment value.
This is no longer the case. 3M is undergoing major changes to become a smaller, safer, and more flexible company. On April 1, the company divested its healthcare business, announced a legal settlement, re-established dividends, and appointed a new CEO on May 1. Growth is also expected to improve as the company focuses on fewer business areas and the manufacturing economy improves.
Bank of America Merrill Lynch analyst Andrew Obin said, “Historically, 3M has performed well during cyclical rebounds. Growth has always been a challenge, but the stock is cheap and good.”
3M's decline over the past few years is indescribable. In 2023, sales fell 3% year over year, while profit fell 12%, and earnings per share fell to $9.24, down from $10.46 in 2018, and sales increased 3.2% in the year. The company's profit margin also declined. Last year's operating margin fell to 20.3% from 24.7% in 2018. The stock had reached 16 times the expected earnings for next year, slightly higher than the S&P 500 index, but the price-earnings ratio at the beginning of 2024 was 10 times, about half of the index's price-earnings ratio. This is not just a symptom of 3M's business slowing; the company may be forced to pay an unknown amount of money to pay for its earbuds and PFAS (an abbreviation for perfluoroalkyl and polyfluoroalkyl substances), which is also putting pressure on 3M's stock.
Things started getting interesting last year. 3M has reached a settlement agreement on the PFAS — the company will contribute up to $12.5 billion over 13 years to clean up and agree to pay up to $6 billion to resolve claims relating to the sale of earbuds to the military. These are large amounts, but they are known and manageable. Former CEO Mike Roman told Barron's: “These two are the most important litigation issues before us, and it's really good to complete these two milestones.” Roman resigned as CEO on May 1, leaving behind a stock that fell about 5% a year during his nearly six-year tenure.
Roman wasn't the only one responsible. Newberg Berman Fund Manager Evelyn Zhou admits “the challenges he faces are huge,” even though she wants him to be more aggressive in addressing 3M's fees. Roman made some tough decisions before handing over control of the company to Bill Brown, the former CEO of L3 Harris Technologies. Roman divested 3M's healthcare division Solventum, leaving the company's remaining businesses to serve transportation and industrial markets, electronics customers, and retain its Scotch brand tape and sticky notes consumer business.
Roman also reset the dividend, clearing the way for Brown. 3M announced plans to use approximately 40% of its annual free cash flow for dividend payments. Wall Street anticipates 3M's free cash flow of around $3.7 billion in 2024, which supports an annual dividend of around $3, a reduction from the $6.01 paid in the 12 months prior to the divestment.
Investors can view reduced dividends and divestments as the cost of resolving balance sheet issues, given the legal issues. As a result of the divestment, Solventum paid $7.7 billion in dividends, while 3M still holds about 20% of Solventum's shares, worth $2.2 billion. Taken together, the new 3M's balance sheet would be equivalent to $16 billion in debt and legal liabilities, net cash, and the amount after stocks. Earnings before interest, tax, depreciation and amortization (Ebitda) are expected to be around $6.4 billion this year. Thus, the 3M debt-to-Ebitda ratio, a common measure of balance sheet strength, is theoretically 2.5 times. (This is theoretical because legal settlements are paid in installments.) This ratio is 1.6 times higher than that of S&P 500 industrial companies, but it's not a cause for concern.
3M's valuation reflects most of the risk, but takes little into account the return. The company's current price-earnings ratio is only 12 times Wall Street's 2025 earnings per share estimate, which is 21 times lower than that of SPDR exchange-traded funds in the industrial select sector. As execution increases and business demands increase, this multiplier should rise. The company reported earnings per share of $2.39 and sales of $7.7 billion, all exceeding analysts' expectations. Organic sales increased 0.8%, the first positive increase in four quarters, and the operating margin of the non-healthcare business unit increased by nearly six percentage points year over year.
These results impressed J.P. Morgan analyst Stephen Tusa, who upgraded 3M's rating from neutral to excessive after the release of the first quarter earnings report, for reasons including “attractive” valuations, a “cleared balance sheet,” dividend cuts, and a “shift in earnings momentum.” His price target is $111 per share — up 14% from the recent $97.33 — equivalent to 14 times his estimated 2025 earnings of $7.85 per share. Based on a historically reasonable price-earnings ratio of 16 times, 3M's stock is approximately $126 per share, up 30% from recent levels.