On Tuesday, 3M (MMM) announced a higher dividend and strong earnings forecast, which sent shares higher by 3% (announcement available here). 3M has been one of the top performers on the Dow in 2013 with shares rallying over 41%. However with the big run, some investors have been taking profits in 3M over the past month with Morgan Stanley recommending profit taking a month ago citing valuation. Do today's announcements answer the valuation concerns or is MMM an overvalued stock?
Let's begin with management's forecast for 2014. 3M expects to earn $7.30-$7.55 for a $7.425 midpoint versus consensus of $7.40. 3M is guiding to a mild beat, though the company does a history of somewhat conservative guidance. This guidance suggests that 3M will grow earnings by about 10-11% in 2014, which is fantastic growth for such a large and diversified industrial conglomerate. Excluding currency implications, organic sales should increase by 3-6% in 2014, in line with expectations.
Importantly, 3M is planning beyond one year with a strategic five year plan through 2017 that the company either affirmed or improved today. Over the five years, management continues to expect 9-11% annual EPS growth, 4-6% organic sales growth, 20% return on invested capital, and 100% cash flow conversion, which will be positive for capital returns to shareholders. This affirmation of the long term plan shows the value in 3M's intensive R&D program that brings to market dozens of innovative products every year.
At the same time, 3M continues to be acquisitive, adding brands and products to its portfolio to hasten growth. Over the five years, management is anticipating deploying $5-$10 billion for acquisitions with the potential for exceeding the top end of the range. While the company tends to focus on smaller deals that cost less than $1 billion, management is not ruling out the possibility of a multi-billion dollar deal going forward. While acquisitions often scare investors (as the acquirer often overpays), 3M has a proven track record of buying companies in an accretive fashion, and I welcome future acquisitions, which will supplement solid organic growth.
Investors also don't have to worry about acquisitions cutting 3M's capacity to pay shareholders. After all, the company announced a 35% hike to the quarterly dividend to $0.855. 3M has increased its dividend for 57 consecutive years and has paid one for 97 consecutive years. With this new dividend, 3M is now yielding a solid 2.6% with a payout ratio of only 46%. Last year, 3M "only" increased the dividend by 7.6%, so the company is dramatically accelerating the growth of the payout. With extremely strong results, the company is generating far more cash than it can responsibly invest, so it is returning more to shareholders. With earnings growth of 10% per annum, investors should continue to expect double digits increases to the dividend going forward.
The most impressive part of the announcement was how dedicated 3M is to share buybacks. Management had previously promised $7.5-$15 billion in share buybacks over the five year period. With its $88 billion market cap, that was a significant program. 3M has drastically raised it, planning to repurchase $17-$22 billion over the five year period, or up to 25% of shares at the current price. In 2013, 3M is buying back roughly $4 billion in shares, and the company plans on keeping that pace going forward. Between the dividend and buyback from 2014-2017, 3M will be returning around $30 billion to shareholders and has solidified its status as one of the most shareholder friendly corporations in America.
Importantly, 3M is both focusing on its shareholders and its business. Many companies can return too much to shareholders and underspend on R&D. With planned acquisitions and healthy R&D spending, 3M is doing both, which is why the company is growing earnings and dividends. 3M is trading at 17.5x 2014 earnings with a long term growth rate of 10%. While 3M certainly isn't very cheap at current levels, I do believe the company deserves a premium valuation given strong growth and increasing dividends and buybacks. At $130, I believe long term investors, especially those focused on growing dividends, should be buyers of MMM. I can respect investors wanting to wait for a pullback given the great run, but if shares drop back below $125, investors should buy 3M aggressively. 3M is a great company that will provide superior returns over the long run.