3M (MMM) shares were rallying another 1% after the bell on Tuesday as the company announced a new buyback authorization (press release available here). The company announced plans to repurchase $12 billion in stock. At current prices, that would give the company the capacity to buy back 14% of the company. Clearly 3M management is very bullish about the future of the stock, but given its strong performance over the past twelve months, should investors be?
It is important to recognize that 3M may very well be the most shareholder-friendly corporation in the country. The company has paid a dividend for 97 straight years, and the company has raised the dividend for 56 consecutive years. In December, the company announced a 35% hike to the quarterly payout to $0.855 (giving shares a current yield of roughly 2.7%). On top of this payout, 3M now plans to aggressively buyback stock. Clearly, management is working hard to reward investors.
Now, it should be noted that there is no definitive end-date to this repurchase authorization. This means that it could take 3M one year or ten years to buy $12 billion worth of stock. Obviously, this news is less impressive if the company takes longer to repurchase shares. I believe it is reasonable to expect the company to take approximately two years to complete this plan. In 2013, the company repurchased $5.2 billion stock but accelerated the program in the end of the year with a $1.7 billion expenditure in the fourth quarter. Given a hastening pace and growing cash flow, a faster pace is reasonable in 2014 and 2015. I would expect the company to spend about $6 billion per year and complete this buyback at the end of 2015. Even if shares rally a good deal, the company will repurchase over 10% of the stock in two years, which will be extremely accretive for EPS.
Investors are then faced with the question of how 3M will manage to repurchase so much stock in such a short period of time. The company currently carries $6 billion in debt but also holds $4.8 billion in cash. With a market capitalization of $84 billion, 3M's $1 billion net debt load is virtually insignificant. In other words, the company could fund this buyback entirely with debt while maintaining tremendous financial strength. This is the benefit of a conservative and shareholder-friendly management philosophy. However, 3M won't need to fully tap the debt markets to fund this buyback thanks to strong operating fundamentals.
In 2014, 3M expects to earn $7.30-$7.55 for a $7.425 midpoint, and it is worth noting 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 superb growth for such a large and diversified industrial conglomerate. Excluding currency fluctuations, organic sales should increase by a solid 3-6% in 2014.
Frankly, a company is unable to increase dividends for over a half-century without focusing on the long term. Fortunately, 3M continues to think beyond the next quarter and the next year with its five year road map that lasts through 2017. Over the next 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 help to fund aggressive capital returns to shareholders. 3M's intensive R&D program continues to lead to new products that contribute to 3M's remarkably consistent revenue growth.
In addition to in-house development, 3M isn't afraid to strike deals and expand its product portfolio to grow revenue and earnings. Over the next five years, management hopes to deploy at least $5-$10 billion for acquisitions. 3M typically makes small bolt-on deals of less than $1 billion, but if an opportunity arises, management has said it is willing to strike a deal worth several billion dollars. While many acquisitions fail due to a high bid price, 3M's track record of making accretive transactions should excite and comfort investors. Depending on the timing of acquisitions and R&D, the company should generate $3.5-$4 billion of free cash flow on cash flow of about $4.8-5 billion in 2014.
While the exact timing of the buyback and acquisitions are not fully known, about half of shareholder returns (the dividend and buyback combined) will be funded by free cash flow and half from debt. Given the extremely low debt burden, this is a sustainable and wise financial strategy. This buyback will help to accelerate EPS growth and provide a lift to shares. However, unless the stock is attractively valued, it is not a wise use of funds. Based on management's guidance, the stock is trading at 17x earnings.
While this valuation may not seem all that cheap, I think this is an attractive valuation for a company with 10% earnings growth and an extremely shareholder-friendly culture. 3M is the perfect example of a stock long-term investors can own, reinvest dividends, sleep well at night, and generate solid multi-year returns. Under $130, 3M is an attractive purchase, and should it fall below $125 if the market corrects further, investors should aggressively get long. With this buyback announcement, 3M reaffirmed its commitment to return capital to shareholders. With growing capital returns and solid growth, 3M continues to be a great long term investment.