This Evergreen Dividend Stock Could Be Getting Even Sweeter Soon – The Motley Fool | Vette Leader

The best companies are experts at constantly innovating and reinventing themselves in response to an ever-changing world. When old tactics don’t suffice in the future, don’t shy away; they evolve.

And that’s exactly what it is 3M (MMM 1.14%) intends to do in its ambitious bid to restructure its business into a smaller and more focused entity. If all goes according to plan, shareholders can look forward to more decades of reliable earnings and dividend growth.

But nothing is guaranteed, so start thinking about what to do with your stocks here.

Twin spinoffs are on the horizon this year and next

As announced on July 26, 3M plans to spin off its healthcare business, which brought in about $8.6 billion of the company’s $26.8 billion in sales in 2021. The transaction is expected to be completed by the end of 2023 and will help streamline its operations and pave the way for further profitable growth.

3M is also in the process of spinning off its food safety unit, but the transaction will close much earlier, on September 1st. But its food safety services were only worth $400 million in 2021, so this isn’t that significant a change for shareholders wondering what the future will hold.

The healthcare spin-off will focus on filtration products for biomedical applications, healthcare software, wound care and oral care. In contrast, 3M itself will double its existing portfolio of worker safety products, including consumer products like tape, and its transportation and electronics segments. Eventually, this increased focus should lead to higher margins and perhaps better market penetration. While the details of the transaction are still in flux, current shareholders will almost certainly be given the option to convert a portion of their 3M stock into shares in the new company — and this is where things could get even better.

Capital allocation priorities, such as the portion of capital earmarked for dividend payments, are not expected to change until the transaction closes sometime next year. With more than 60 years of steadily increasing its dividend, the company is a dividend king, but it’s unclear whether the spin-off will be interested in remaining a member of the royal club.

In fact, management is already hinting that the two companies will appeal to different investor groups, which could mean the healthcare company will focus more on growth than earnings.

If that’s the case post-transaction, investors could benefit from faster growth for both companies as the streamlining should improve the original 3M’s performance after what could have been a challenging few quarters. It could also be an opportunity for shareholders to sell their stakes in the new company at a premium to reinvest in the original 3M, assuming there’s an option to do so, as there will be with the food safety spin-off.

It may not all be smooth

Current expectations for the new healthcare company are that it will have an earnings margin before interest, taxes, depreciation and amortization (EBITDA) of around 31%. That sounds pretty good, but investors should recognize that the new healthcare company could be a little riskier than their current 3M holding. Currently, 3M has $17.2 billion in debt and lease obligations, and the new healthcare company will shoulder a hefty portion of that burden when it separates.

Since the second-quarter update, 3M’s quarterly free cash flow (FCF) is down 41% year over year, and that could become an issue if the trend continues through the spin-off. Alternatively, the transaction could help dampen the downside if it costs too much to spur growth in the healthcare segment. 3M is also currently pausing its share buyback program, so this theme is key to future returns.

It’s likely that 3M will be able to trim and improve its performance enough to keep paying its dividend into 2023 and beyond. Nonetheless, this will be a big shift for a relatively stable company, and there might be some bumps along the way. Healthcare is the fastest-growing and most profitable segment, so there may be near-term margin squeeze, not to mention some growth slowdown, before new investment in the remaining segments begins to yield profits.

3M’s stock price could take a hit as the company adjusts — but this will be an opportunity for investors with a long time horizon to pick up a few shares. Just keep in mind that the new 3M might take a while to gain traction and achieve the same level of financial stability it’s known for, and it’s unlikely to outperform the market anytime soon.

Leave a Comment