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Shares of 3M Company (NYSE:MMM) have seen continued tough times amidst mostly legal concerns, as I concluded in an article dating back to August of last year called: “Lingering Lawsuits.”
I noted that apparently serious lawsuits arrived at a time when the business has seen softer organic performance already, while the economy appeared to be cooling down as well, with a strong dollar creating additional headwinds. While valuations looked quite reasonable, the uncertainty cast by the lawsuits made this far from an automatic buy.
A Recap
Unlike so many industrial names, 3M typically has deserved a license to operate as a conglomerate, as historically strong corporate capital allocation strategies meant that no conglomerate discount was apparent in its share price in recent years. The peak of the shares and company appeared to be in 2018, a time when shares peaked at $250 per share, supported by the “America-First” policies of president Trump.
What followed was a steep $6.7 billion deal to acquire healthcare company Acelity. I was fearful of a strategy of buying high and selling now, a strategy which has caused serious pain to General Electric (GE), among others. The company generated about $32 billion in sales in 2019, on which it earned just over $9 per share, as that apparently was the (temporary) peak.
After a mixed 2020, the company grew 2021 sales to $35 billion, as earnings topped $10 per share, with net debt of $12 billion translating into a modest 1.3 times leverage ratio. With shares down to $150 early in 2022, the situation looked a bit more constructive already, given the resulting earnings multiple and a 3% dividend yield, but it still went all downhill from here.
2022 proved to be a tough year, as shares had fallen back to $130 by August, driven by a cocktail of environmental liabilities hurting the business and generally softer performance. In March the company “invested” another EUR 150 million to address issues at its Belgium PFAS factory, while the company reiterated the adjusted earnings guidance calling for earnings around $11 per share.
In July, another PFAS settlement was announced, this time totaling EUR 571 million, as the company announced its intention to spin off the healthcare business, the second large “divestment” after it had merged the food safety business with Neogen (NEOG) in a deal which was far from a success story.
Over the summer, 3M aimed to proceed in Chapter 11 procedures for its Aearo Technologies business following defective combat earplugs, as the units faced up to a quarter of a million dollars in in claims, with nearly a billion dollar fund established when the business was acquired in 2008. With courts not willing to ring-fence the liabilities to this entity alone, leaving potential exposure to all of 3M, investors were getting worried. This came at a time when the company cut the adjusted earnings guidance to $10.55 per share, all while net debt inched up to $13.2 billion.
While earnings power and leverage are not the immediate problem, investors are fearful about the news on Aearo, PFAS and other forever chemicals. Notably, Aearo seems to be a huge pain, as preliminary trials awarded more than a quarter of a billion dollars in damages for just 16 trials. However, with potential of a quarter of a million claimants, the bill could be huge, even if many cases could be settled for an amount far less and payments could be spread out over time.
Trading at $130 while posting $10 in earnings per share, the potential appeal had to come from clarification and quantification of the environmental and health liabilities, leaving me still very cautious.
Relative Stability
Since August 2022, shares have not moved on a net basis, now trading at $127 per share, albeit that shares have fallen to a low of $107 in the meantime. After closing on the spinoff of the food safety business into Neogen in September, the company posted third quarter results in October.
Third quarter sales fell nearly 4%, to $8.6 billion, amidst softer demand, a strong dollar, and the impact of the food safety divestment. Net debt was pretty stable at $12.1 billion despite nearly a billion dollars spent on share buybacks so far this year, a very-telling story despite the pending lawsuits. The company cut the adjusted earnings per share guidance further to $10.10-$10.35 per share.
In November, 3M and the EPA reached an agreement to address PFAS in the Cordova region drinking water. More water sampling will be enabled as well as a $170 million water treatment system will be constructed.
In November, 3M continued to pay out a dividend of $1.49 per share, now having paid dividends without interruption for more than 100 years. Towards the end of the year the company announced to end PFAS manufacturing by the end of 2025. This decision triggered an impairment charge of up to a billion and will impact the business in a minor degree. PFAS revenues total some $1.3 billion, accompanied by 16% EBITDA margins, as some more future charges are likely seen beyond the fourth quarter results.
We know now that fourth quarter results will not be pretty amidst the cooling economy and impact of the safety foods safety operations, while charges are taken in relation to PFAS. With earnings so far this year coming in at $7.82 per share, that suggests earnings trending around the $10 per share mark, or just below that with EBITDA now trending around $8 billion, pushing up leverage ratios to around 1.5 times.
Concluding Thoughts
In the nearly half a year period since August, little has changed for 3M Company on the corporate front. 3M Company posted third quarter results which were in line with estimates and has taken actions to prevent more liabilities in the future by seeking remediation efforts and cutting production, but the outcome of the current legal woes remain highly uncertain.
Given all these dynamics, I continue to hold a rather cautious stance on 3M Company here, hoping that more information is provided on these cases into the new year.
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