Dividend Analysis - 3M Company (NYSE:MMM)
19 June 2007Today, we will be looking at a perennial dividend payer - 3M Company. 3M Company most aptly trades under the symbol MMM on the NYSE. It is included in the following indexes: Dow Jones Composite, Dow Jones Industrial, S&P 100, S&P 500 and S&P 1500 Super Comp.
Company Profile:
From Yahoo Finance
3M Company operates as a diversified technology company. It operates in six segments: Industrial and Transportation; Health Care; Display and Graphics; Consumer and Office; Safety, Security, and Protection Services; and Electro and Communications. Industrial and Transportation segment offers tapes, coated and nonwoven abrasives, adhesives, specialty materials, supply chain execution software solutions, closures for disposable diapers, and components and products that are used in the manufacture, repair, and maintenance of automotive, marine, aircraft, and specialty vehicles. Health Care segment provides medical and surgical supplies, skin health and infection prevention products, drug delivery systems, dental and orthodontic products, health information systems, and microbiology products. Display and Graphics segment offers optical film and lens solutions for electronic displays; touch screens and touch monitors; computer screen filters; reflective sheeting for transportation safety; and commercial graphics systems. Consumer and Office segment provides office supply products; stationery products; construction and home improvement products; home care products; protective material products, including consumer health care products, such as bandages; and visual systems products. Safety, Security, and Protection segment offers personal protection products, safety and security products, energy control products, cleaning and protection products for commercial establishments, and roofing granules for asphalt shingles. Electro and Communications segment offers electronic and interconnect solutions, micro interconnect systems, high-performance fluids, high-temperature and display tapes, telecommunications products, and electrical products
This is a large cap stock with a market capitalization of $63.10B.
Company Fundamentals:
I want to start with the Return on Invested Capital (ROIC). And the ROIC has been consistent and solid throughout the 10 year period. The 5 year average is 28.20%.
The return on equity (ROE) confirms management’s great job. The 10 year average is 29.30% and the 5 year average is 31.62%. Excellent, consistent returns on equity.
For Warren Buffett, equity growth rate (or the book value growth rate) is most important. No matter, Warren wants to know that a company is increasing its value - even if it doesn’t get reflected immediately in the share price. 3M Company has not had stellar equity growth rates. In fact, there have been many sub par years. Eight of the last 10 years have had equity growth rate below 7%. And 3 of those 8 years were negative.
Looking at the whole 10 years, we see an equity growth rate of 8.17%.
Earnings per share growth rate has been fairly steady in the 11% range. However, 2006 had a low growth rate of 4.66%.
Sales growth rate has been fairly slow and consistent. Over the 10 year period, 4.76% growth rate was achieved. However, it has gotten better. The 5 year average is 7.85% and 2006 had a growth rate of 8.30%.
Dividend Fundamentals:
Current dividend yield is 2.19%. That compares favourably with the Dow Jones Industrial Average dividend yield of 2.25%.
The dividend growth rate has been rather anemic over the 10 year period but has picked up since 2004 and grown at 9.09%, 16.67% and 9.52% respectively. However, over the 10 year period, the average dividend growth rate has been 5.99%.
Cash flow growth rate has exceeded the dividend growth rate. And as such, the dividend payout ratio has decreased over the 10 years from a high of 58.82% to today’s current payout ratio of 40.98%. This is a very conservative payout ratio and 3M does have room to maneuver in order to increase the dividend growth rate.
Historical Dividend Yields:
The 10 year average high dividend yield is 2.68%. And this time, I also calculated the 5 year average high dividend yield which was 2.36%. I was thinking that I should use the 5 year average as it is more indicative of current trends. But interestingly enough, the 10 year average high dividend yield is closer to the high dividend yield of 2006!
I will stick with the 10 year average this time around. That would lead me value 3M at $71.63. At the current price of $87.67, that is a premium of 22.40%.
From my dividend yield calculations , this stock appears to be quite expensive. Let’s see what our other value methods say.
Graham Number:
Calculating the Graham number is easy: square root of (22.5 x EPS x BPS). In this case, we have square root of (22.5 x 4.60 x 13.56) which gives us a Graham number of $37.46. That implies that today’s price is a premium of 134%. Well, Graham definitely finds this stock expensive as well.
Present Value:
Using the present value method, we need to calculate the value of the stock 10 years from now.
The future P/E is determined by looking at the historical patterns. In fact, 3M has traded in a very tight P/E range. The most conservative P/E happens to be its current P/E of 19.06.
Equity growth rate is the best indicator of future EPS growth rate. Looking at the equity growth rate of MMM, it has not been stellar. The 10 year average is 7.86% and 2006 had a growth rate of 1.31%. I will use the 7.86% for my estimate. Analysts have estimated 10% future EPS growth rate. I think I will stick with 3M’s track record and use my 7.86%.
With such a low future EPS growth rate, then a rule of thumb for future P/E is twice the future EPS growth rate. That means a future P/E of 15.72 (which is lower than our initial estimate of 19.06).
Using these numbers, the current EPS will grow to $9.80 in 10 years. At a P/E of 15.72, the future stock price will be $154.04. If we discount at 15%, then the present value of that future stock price is $38.08.
Wow. The Graham number came out to $37.46 and compares nicely with our calculation of $38.08 - and with a LOT less work! Needless to say, these 2 methods both confirm that 3M is overvalued.
You can find all my calculations here.
Conclusion:
Although 3M Company has grown its dividend for the last 25 years, it is not growing it at a fast rate. All my valuation methods show that 3M is currently overvalued. And the slow dividend growth will not help alleviate that over valuation in the medium term.
The low equity growth rate also concerns me. Although management has done a great job managing the capital at its disposal, it is not growing the equity consistently.
Disclosure: I do not own shares in 3M Company (MMM)
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