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3M is a large diversified manufacturer and technology company. With over 60,000 products in more than 200 countries, it is not surprising that the company is among the leading manufacturers in many of the markets it serves.
The company currently operates in four business segments; Safety and Industrial; Transportation and Electronics; Health Care and Consumer.
As a dividend King, the company has an impressive 60-year record for increasing dividends. But, of course, a 60-year streak is no easy feat, and such a record deserves attention for any dividend growth investor.
This short article will analyse some key elements to determine if MMM stock dividend safety.
Payout Ratios
One of the first metrics to check MMM stock dividend safety is the payout ratios. We look at both the earnings payout ratio and the free cash flow payout ratio.
On both ratios, a value under 70% is preferred, but we put more weight on the free cash flow ratio. The reason is that earnings can be affected negatively or positively by once-off events. Therefore, I like to check at least five years to see a better reflection of a company’s earnings power.
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Earnings payout ratio
The earnings payout ratio is calculated as Dividends Per Share / Earnings Per Share and determines what percentage of the company’s EPS funds the dividend. Therefore, a combination of revenue and earnings growth and a low payout ratio is usually a good sign for a sustainably increasing dividend.
In 2020, the Payout Ratio was 63% which is below our 70% safety net. The 5-year average is also below 60%. Over the same five-year period, earnings have grown at a compound annual growth rate of just 0.6%.
The payout ratio increased as the dividend growth rate outpaced the earnings growth rate.
Usually over an extended timeframe, the dividend growth rate will reduce to match earnings growth, which we saw with 3M in 2021 when the company only increased the dividend by 2%, considerably lower than the three-year average of 7.75%.
Free Cash Flow payout ratio
While earnings per share is a good indicator, there are ways that companies can manipulate these figures. A better indicator of some investors in free cash flow. The Free cash flow payout ratio is calculated as Total Dividends / Free Cash Flow and tells you what percentage of the company’s free cash flow is being used to fund the dividend.
In 2020 the payout ratio was 52%, and the five-year average is 56%. In addition, Free cash flow is growing slowly, with a five-year average of 1%. Â Worryingly this is below the five-year dividend growth rate of 7.48%
Interest Coverage
Interest coverage is probably one of the most important metrics that a dividend growth investor can use when checking MMM stock dividend safety. The more debt a company has, the greater the amount of interest they have to pay. In a low-interest environment, this may not burden the companies cash flow, but this could change as interest rates increase. The more cash a company has to pay out on debt, the less it will have to pay a dividend.
The interest coverage ratio calculation is EBIT/Interest Expense. Interest coverage is essentially the number of times a company can pay its interest with its earnings before interest and taxes. A number above three is desirable for most companies.
3M has an interest coverage ratio of 13.75, which is very high and much better than the industry average of -2.16
Debt/Equity
The debt to equity ratio is a standard financial leverage ratio representing the debt and equity used to finance a company’s assets. A high percentage of debt concerning equity is usually a red flag for dividend growth investors.
The D/E ratio is calculated by dividing a firm’s total liabilities by total shareholders’ equity.
3M has a high debt to equity ratio of 3.41, which is above the industry average of 0.61 and suggests the company is highly leveraged. While the Interest coverage indicates that they have no problem meeting their minimum debt obligations, the debt/equity is relatively high.
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Dividend Growth
3M’s dividend growth rate has exceeded the average dividend growth rate of the S&P 500 for the last 15 years. Investors usually use the S&P 500 as a benchmark to beat over the long term, so investing in companies with a history of outperforming the index is sometimes preferred. The last increase of 2% comes off the back of the COVID-19 pandemic and is in line with the companies increases in the previous financial crash. As the world gets back to normal, we may see the dividend increase by 5% or more.
dividend per Share via IOCHARTS.IO
Conclusion
From the data above, it is clear that dividend growth has outpaced both earnings and cash flow. Of course, in an ideal world, it would be reversed. However, there is some comfort knowing that both EPS and FCF are growing, just at a much slower pace.
The dividend safety rating scoring system is displayed in the image below. This rating system will not guarantee the safety of a dividend but acts as an indicator of when I should revaluate existing companies as a cut seems likely if the value is below 49.
The quick analysis above 3M scored 62 out of 100, which means they are a medium risk to cut the dividend.
The main concerns with 3M are the increasing debt and the slow rate of EPS and FCF growth compared to the dividend.
However, the company has a wide moat and sells essential products all over the world. Therefore, it is not a company that will go out of business anytime soon. As an investor in 3M, I would have no real concerns about a dividend cut in the foreseeable future.
If you would like a copy of the template I use to perform fundamental analysis then feel free to grab your copy below. I explain how I use the template here!
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