3M is a dividend king with a 60 year record of annual dividend increases. The company raised its quarterly dividend by 15.70% to $1.36/share in January 2018. This increase reflects 3M's confidence in its ability to continue generating premium returns in 2018 and beyond.
Over the past decade this dividend growth stock has delivered an annualized total return of 14.40% to its shareholders. Future returns will be dependent on growth in earnings and starting dividend yields obtained by shareholders.
The company has managed to deliver a 3.50% average increase in annual EPS over the past decade. 3M is expected to earn $10.33 per share in 2018 and $11.19 per share in 2019. In comparison, the company earned $7.93/share in 2017. If we adjust for the $1.24 one-time item, related to the new tax laws implemented in 2017 however, earnings per share would have been $9.17.
The strength of 3M’s business model is largely driven by three key strategic levers: active portfolio management, investing in innovation, and business transformation. Management believes that these levers, combined with more aggressive capital deployment, will drive enhanced value creation. Over the last several years 3M has taken significant actions to strengthen its technology capabilities, improve portfolio and cost structure, and make the company even more relevant to customers. 3M’s technology platforms and its manufacturing scale allow it to achieve the lowest unit cost in most of the categories in which 3M competes. This also ensures high margins as well.
The first lever – Portfolio Management – is increasing customer relevance and allowing 3M to focus on its most profitable and fastest-growing businesses. 3M has realigned from 40 businesses to 24 over the past five years. This has resulted in SG&A savings of around $250 million. Continued portfolio management will also help to optimize its footprint, and the company is targeting $125 million to $175 million in additional operational savings by 2020. The company is also expecting that acquisitions, net of divestitures will result in a net 1% growth in annual sales over time. Portfolio management is strengthening 3M’s competitiveness and making them even more relevant to our customers and the marketplace.
Investing in Innovation is the second lever. 3M plans to increase investments in research and development to about 6 percent of sales. The company spends over 6% of revenues on R&D, and has been able to discover innovative products to bolster its bottom line. 3M also allows it engineers to spend 15% of their time on their own projects, which has resulted in a lot of innovation. The company has a proven track record of making money on its research dollars spent, as it tries to find applications with a customer centric point of view. The company invests in research and development to support organic growth, and enhance the company’s strong margins and return on invested capital.
3M continues to make good progress on its third lever – Business Transformation – which is enabling the company to better serve customers with even more agility and efficiency. Its Business Transformation lever aims to creating value for the company and its customers. By 2020, this initiative is expected to deliver $500 to $700 million in annual operational savings, and an additional $500 million reduction in working capital.
The company is also focusing on investments in priority growth platforms such as auto electrification, air quality and personal safety. The company is also focusing investments on its strong global business model including in the U.S. and China.
The company provided a rough roadmap of how it plans to get from the $9.17/share earned in 2017 to the earnings expected in 2018. I believe that a picture is worth a thousand words in this case.
Earnings per share have also been aided by share buybacks. The number of shares outstanding has decreased from 732 million in 2007 to 613 million by 2017.
The annual dividend payment has increased by 9.40% per year over the past decade, which is higher than the growth in EPS. Future rates of growth in dividends will be limited to the rate of growth in earnings per share.
For more than a century the strings of 3M business model has enabled the company to invest in the business while also returning cash to our shareholders. All of this has included a strong steady and rising dividend which is management sees as the hallmark of the enterprise.
In the past decade, the dividend payout ratio has increased from 34% in 2007 to 59% in 2017. I believe that 3M's dividend is safe. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently, 3M is slightly overvalued at 20.40 times forward earnings and has a current yield of 2.60%. This quality company may be worth a second look on further dips in the stock price below $206/share. More conservative investors who are using FY 2017 earnings per share may require dips below $183/share before considering 3M.
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