No dividend is ever guaranteed, and Dividend Kings aren’t an exception
Even iconic dividend payers such as 3M with 65 years of consecutive dividend raises can run into trouble.
Any dividend is only as good as the fundamentals that back it up.
3M(MMM) has been a stalwart in many dividend portfolios and a big component of most dividend-focused ETFs.
However, it’s recent troubles have put the safety of the dividend in question.
There’s a reason why 3M’s last few dividend raises have been paltry <1% token raises.
The Risk
Why is 3M dividend in danger?
- Lawsuits
- High Payout Ratio
- Solventum spin-off
In June 3M agreed to pay $6B to around 250,000 U.S army members who claimed that 3M’s earplugs were defective, causing hearing loss and tinnitus. The $6B is structured to be paid out across the next 5 years so let’s say $1.2B per year (exact timing is unknown).
Another lawsuit (PFAS) is related to contaminated drinking water and the settlement requires 3M to pay a “net present value” of $10.3B across the next 13 years. The exact timing of payments is unknown, but spread out evenly it would be a around $0.8B per year.
So we have around $2B in yearly settlement payments across the next 5 years – that’s significant.
Over the last decade, 3M has generated around $5.2B of annual free cash flow on average.
$2B of yearly settlement payments would make up around 38% of yearly free cash flow.
Combined with the current free cash flow payout ratio of 65% – it’s clear that it would be a threat to the dividend.
It gets even worse…
3M is spinning off the “Solventum” segment of its operations.
This business segment has contributed to around 25% of annual earnings to the whole company.
3M is losing 1/4 of its earnings generating potential.
Since the payout ratio will already be stretched to the limit with the settlement payments, losing those earnings will be a big problem for the sustainability of the dividend.
The Hope
What gives the company some breathing room in this challenging time – is its A+ rated balance sheet.
With its net debt load at just 1.3x yearly EBITDA, the company can comfortably cover its financing obligations even during troubling times.
It can also access debt markets to raise cash at favourable terms to fund the settlements and maintain its dividend.
However, that’s a short-term fix and dividends should always be covered by free cash flow.
The Verdict
3M is in a perilous position and might have to sacrifice its dividend for the benefit of the whole business.
The combination of around $16B in settlements to be paid, elevated payout ratio and losing 1/4 of its earnings power will put a big strain on the managements ability to reward shareholders with dividends.
The management is aware, that many investors are in it for the dividend when investing in 3M – and cutting the dividend will likely put pressure on the stock price.
However, for the benefit of the company’s long-term prospects – a dividend cut might be the prudent decision here.
Disclaimer: I don’t have a position in shares of 3M.
