3M's Dividend Is Overvalued And Growth Is Risky

Jun.12.12 | About: 3M Company (MMM)

3M (NYSE:MMM) is a diversified technology company with a global presence in the following businesses: Industrial and Transportation; Health Care; Consumer and Office; Safety, Security and Protection Services; Display and Graphics; and Electro and Communications. 3M is among the leading manufacturers of products for many of the markets it serves.

3M has been a steady dividend payer over the past decade. It has increased its dividend every year, even throughout the recession and financial crisis. However, the growth in its dividend has been limited, especially over the past five years.

Year Dividend Dividend Growth
2002 $1.24 --
2003 $1.32 6%
2004 $1.44 9%
2005 $1.68 17%
2006 $1.84 10%
2007 $1.92 4%
2008 $2.00 4%
2009 $2.04 2%
2010 $2.10 3%
2011 $2.20 5%
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Furthermore, 3M had a challenging time growing its free cash flow per share over the past 5 years, and the company had negative growth in '08 and '09.

Over the entire decade, however, the company has churned out a respectable ~7% compounded annual growth in its FCF/share. And the payout ratio is currently extremely low at 28%, which provides room for expansion even if FCF does not grow that quickly. So it's possible that 3M may be able to produce mid- to high-single-digit dividend growth in the future.

Year FCF/Share Payout Ratio (Div/FCF per share)
2002 $3.75 33%
2003 $4.29 31%
2004 $5.07 28%
2005 $5.55 30%
2006 $6.71 27%
2007 $7.29 26%
2008 $6.65 30%
2009 $6.12 33%
2010 $7.43 28%
2011 $7.94 28%
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Using the dividend discount model, I determined the value of the company based on its future dividend payments.

Dividend Discount Model

In performing this valuation, I made several assumptions. First, I used 9% as my discount rate, based on the long-term average return of the stock market. Next, I used 3M's 7% dividend increase to estimate the full-year dividend amount for 2012 ($2.36/share). I used a constant growth rate of 8% for 2013-2017, and a 6% growth rate for 2018-2022. Finally, I assumed a 5% perpetuity rate after 2022.

Based on these assumptions, I calculated that 3M's intrinsic value is ~$73 per share. At its current price of $86, the stock is priced 17% above its intrinsic value and appears to be overvalued.

3M's provides a 2.7% dividend yield that is not likely in danger of being reduced. However, the current stock price assumes a dividend growth rate that 3M is unlikely to achieve, given its historical dividend growth. Therefore, long-term income-oriented investors may want to look for a more favorable risk-reward opportunity.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the dividend growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.