An industrial giant in difficulty 3M (NYSE:MMM) could well reach a milestone after an extremely difficult 2023. The company has been hit by lawsuits of unprecedented scale from so-called “chemicals forever“, agreeing to pay up to $12.5 billion for damages. As if that wasn’t enough, 3M also has to pay around $6 billion to defective earplugs in another financial and reputational blow for the company. However, we know that Wall Street is looking to the future and these events are now known and quantified.
The stock is up sharply from its October low, but I foresee at least temporary problems ahead for the stock. If you’re a dividend and/or value investor, you’re probably licking your proverbial chops right now with 3M’s yield and forward P/E ratio. This has merit, but I think you should wait as you will likely get a better price in the coming weeks. come. For these offsetting factors, I am suspending 3M for the time being. Let’s dig.
First, the bad news
I mentioned that 3M was in the middle of a massive uptrend, and we can see the extent of it below. 3M is indeed in an uptrend currently, and any pullback can be bought. The problem is that I think a pullback is imminent and I wouldn’t pursue the stock here.
I marked the downtrend line that was in play for most of 2023, but it is no longer a factor; as long as stocks stay above this downtrend line in a pullback, it’s a thing of the past. We also have sharply rising moving averages that can and should act as support, contributing to the emerging uptrend.
However, 3M is extremely overbought. The PPO is +3 and the 14-day RSI has been in overbought territory for weeks. I’ve marked the previous three occasions where the PPO reached ~3, and all three resulted in massive withdrawals. Does this guarantee anything this time? Of course not. However, the story generally rhymes, and I fully expect some cringe here. We also have very substantial resistance at ~$109, which is exactly where the stock last closed. This confluence of factors makes a downturn much more likely.
The logical question then becomes how much? Given the extreme momentum we are seeing here, I would favor a pullback towards the ascending 50-day moving average in blue. It’s currently $97, but it’s rising quickly. We could easily see a move towards $100 or $102 to hit the 50-day MA, and I would view that as a buying opportunity.
Not only is the stock very overbought, but the seasonality is quite harsh for the next two months, again favoring patience.
3M’s last five January/February periods produced positive returns only 40% of the time, and annualized average returns of -36%. This isn’t surprising, and I think the combination of overbought stocks and very negative seasonality is a bad combination for the bulls right now. Just be patient and average in your position, if you wish.
Now, some (relatively) good news
Let’s be clear ; 3M’s shares plunged because they were well deserved, not because Wall Street misunderstands the company’s prospects. The company is facing huge litigation payouts over several years, but other than that, growth just hasn’t been there.
EPS for 2023 is expected to be approximately 10% lower than 2022, which was itself lower than 2023. 2018. This company is struggling to get things done, and I don’t think that will change significantly in the future. Management continues to expect that spin off of the health care sector will take place during the first half of this year, which introduces a generic character. What’s interesting is that among the major operating segments, healthcare was the only one to generate organic growth in the most recent quarter. If 3M’s growth is to deteriorate after the spinoff, the stock will leave a lot to be desired, to say the least. We will see.
On the positive side, margins in the healthcare segment are near the bottom for 3M, so it is entirely possible that we will see an improvement in the margin profile post-spinoff. That would help, and 3M desperately needs help in this area.
Gross and operating margins have been in slow and steady decline for years, although there has been a slight improvement recently. 3M needs to find a way to increase its revenue and needs better margins. If the spin-off helps the latter, that’s part of the battle won. But again, this company isn’t necessarily in great shape, which is why its stock has been mercilessly beaten down throughout 2023.
In case it’s not clear, I’m not a big fan of 3M from an EPS growth perspective, as it has fundamental problems regarding revenue growth and margins. However, it is very cheap at the moment, and it’s just enough to keep me away from a sell rating.
The stock currently trades at just 11 times forward earnings, which is 5 times below its 5-year average and 10 times below its peak multiple over the past five years. The company’s growth profile is worse than in the past, as we’ve already discussed, and this partly explains the contraction in multiples. I also believe that the consequences of litigation are responsible for a large number of multiple contractions, but with the results of these now largely quantified, I think these consequences will begin to abate. This could lead to further multiple expansion in the coming months. Wall Street can face known risks; it’s the uncertainty that drives stock prices down, but I think the vast majority of the uncertainty has been lifted here.
Since 3M is a legendary dividend stock, there is another way to value it, and that is the yield itself.
3M’s historical yields were typically around 3%, but they are now almost double that level, even after the big rally we’ve seen. The 5.5% yield is not only exceptional on an absolute basis, but on a relative basis it is very high. This means that the price-to-earnings ratio and the dividend yield are both in the buy zone and, as I said, I think they are effectively pricing in the bad news we saw for the company at over the last few quarters.
Finally, I think that the dividend could continue to be paid given the litigation risks and the currently known profit profile. Below we have free cash flow and ordinary dividend payments on a trailing twelve-month basis over the past few years, in millions of dollars.
The dividend currently stands at about $3.3 billion per year, and even with declining profits, 3M produces nearly $5 billion in FCF per year. Could this change? Of course. However, given its status as Dividend King with 64 consecutive years of increases, I believe the dividend can and will be defended.
Putting it all together, we have a stock in a fundamentally difficult situation, but with a valuation and yield that takes this risk into account. The stock price chart suggests to me to be cautious, however. I think if you’re interested in owning 3M, you’ll likely have an opportunity to buy at a better price in the coming weeks. For now, it’s a wait and see.