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3M Company: Between a High Yield Bond and an Index Fund (NYSE: MMM)

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3M Company (NYSE: MMM) is what many may consider a “boring dividend stock”. It is one of 30 stocks in the venerable Dow Jones Industrial Average, and one of the only stocks in the world to be able to claim 63 consecutive years. of annual dividend growth. With MMM shares now selling at a 25% discount from a year ago, I consider it a good time to assess the future growth and revenue prospects of this name, and the best ways to harvest profits from his profitable business.

This article consists of two parts. First, I examine the fundamentals of MMM as a whole through a framework of rules of thumb which I refer to by the acronym “GINA”, which stands for grower, Irevenue, NOTnarrative, and AAnalyst estimates. The first two of these checks are more retrospective and objective, while the last two are more forward-looking and subjective. Second, as a continuing shareholder of MMM, I review and compare 3 options strategies and their impact on my overall risk versus reward on this name going forward.

The growth of 3M

It’s unlikely that many readers would consider MMM a “growth stock”, but at first glance its revenue growth over the past 37 years looks impressive, steady and appears to be continuing to the present day. . While MMM’s EV/Sales multiple isn’t as cheap as it was before 1995 or during the depths of the 2008 financial crisis, MMM appears to be trading at its lowest levels since 2013 by this metric.

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MMM Revenue (TTM) data by YCharts

In my book, a more important and often underestimated metric for assessing the quality of growth is tangible book value growth. While there are many reasons why a company’s book value per share may decline year over year, a long-term decline in book value per share, especially one that keeps that number negative for many years, is one that I often take as a harbinger that future growth is slowing down. As I explained earlier, using McDonald’s (MCD) as an example, this pattern of decreasing and negative tangible book value can be taken as a sign that a company is using borrowing and buybacks to support returns while opportunities for internal reinvestment are drying up.

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Tangible Book Value Data (per share) MMM by YCharts

3M revenue

As a long-time dividend payer and dividend producer, MMM would seem to be the best-suited stock for the “Income” portion of my “GINA” checklist. Yes, past dividend growth has been impressive, but I’ve recently become particularly wary of companies that increase their quarterly dividend by a penny a year or less, as MMM has done for the past three years. . This model tells me that MMM wants to clearly signal to the market that it intends to stay “in the club” of stocks that increase their dividend every year, but it is no longer able or willing to do so at the rate it did in 2014. – 2018. The fact that MMM’s yield is now back above 4%, a level that has only been seen twice in this chart, may be a sign that investors believe that a yield of 4 % is the bulk of what they’re going to get, with only a token amount of dividend. inflation-compensating growth, or even that.

That’s why I compare MMM to a bond or preferred stock yielding 4-5%, whose coupons or dividends are guaranteed not to increase. The penny increases can be seen as the last remaining compensation for the higher risk of owning MMM stock compared to a bond or preferred stock.

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MMM Dividend Data by YCharts

The oldest 3M bond I found was below 3.7% MMM of 2050, issued as a 30-year bond in 2020, and is now trading at a yield of 4.6% until to maturity for the next 27.5 years. One would have to be both pessimistic enough about 3M’s future dividend growth and confident enough that 3M will not go bankrupt to think that this 2050 bond yielding only 0.5%/yr more than the stock is a better investment than MMM stock.

3M Bond Yield 2050

FINRA TRACE

If we look at earnings and cash flow supporting the dividend above (and after bond interest payments above), we see an equally impressive level of growth, albeit with a very recent decline. I should take a closer look to find out why this decline has occurred and, like the drop in book value seen above, it may be a sign that dividend growth may stall or even reverse. .

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MMM Data on Net Income (TTM) by YCharts

The 3M Story

The 3M “narrative” may not be exciting, but I’m focusing here on the company’s diversification across businesses and geographies. Just as I compared MMM stock to a bond in the previous section, here I compare it to an index fund, whose exposure we can break down by sector and country. No, MMM stocks aren’t as diverse as the S&P 500, but they’re probably no less diverse than smaller total market index funds like those in Canada, Australia, or Singapore.

This first chart comes from MMM’s 2021 Form 10-K and shows how their revenue is primarily diversified across four business sectors: Security and Industrial, Transportation and Electronics, Healthcare, and Consumer.

MMM revenue by business segment, 2020 vs 2021

3M Form 10-K for 2021, page 21

This second chart is from page 22 of the same 10-K, showing how, not too unlike a globally diversified index fund, only about 50% of MMM’s revenue comes from the Americas, 30% from Asia. -Pacific and the remaining 20% ​​of this region in between.

3M 2021 revenue by geography

3M Form 10-K for 2021, page 22

While some may not consider the above two charts to be truly a “story”, what I mean is that it’s not a name that many dividend investors need to delve into to decide whether a position 1% to 5% gives them a diversified position. sufficient source of return.

3M analyst estimates

3M’s earnings are pretty well watched and watched by 19 analysts through 2023 and 2 analysts through 2026, who I’m sure all know more about this company than I will ever know. The consensus appears to be for continued mid-single-digit revenue and earnings per share growth for the foreseeable future, but revision trends appear to be negative at the time of this writing. Together, these signs tell me that MMM stock is probably reasonably priced, not deeply undervalued, but also not the stock most likely to drop 50% in the next 5 years.

3 options strategies on 3M

MMM is primarily a stock worth buying for its income, not its growth, and so naturally I find it worth considering strategies to enhance yield or reduce risk on this action. Below are three options strategies that I evaluate, all using data from the Seeking Alpha options chain.

Option Strategy #1: Covered Call

The first options strategy learned by many “newbie” investors is covered call writing. In this strategy, I receive an initial premium in exchange for giving up the stock’s rise above a certain strike price on an agreed expiry date. In this case, the option term I’m considering is January 2023, partly because prices look good, but also because if my shares are recalled, I can defer my capital gains taxes until next year for shares held in a taxable account.

Of the strikes below, my choice would be to write the call of 150 strikes, as 150 happens to be roughly where the return on MMM would fall below 4%. My current view on MMM is that it is worth buying at yields well above 4% and starting to take profits when the yield drops below 4%.

MMM calls January 2023

Looking for Alpha

If I can receive a premium of 5.50 for the call expiring in 147 days, my return is in two parts:

  1. The 5.50/share premium is money I get up front that supplements my dividend. On an annualized basis, this covered call premium provides a yield improvement of (5.50 premium/150 exercise)*(365 days per year/147 days to expiration) = 9.1% per year, more
  2. I could still profit from any appreciation in the MMM stock from its current level of around 142.75 to 150. That’s another 5% I would profit over the next 147 days if the stock reaches 150 or higher, but I am writing to call to get paid expecting it to reach that level, if at all.

Option Strategy #2: Buy a Longer Term Put Spread

A second, very different, options strategy I consider is one where I buy downside protection against a significant decline in MMM’s stock price. I would do that by buying a put, and like all insurance, it costs more the more protection I need. The string of put options below are of those expiring in January 2024, as I am looking to hedge against a longer term steep decline, and the strikes that stand out to me here are the round numbers 125 and 100. If I buy the 125 put strike and sell the 100 put strike (aka, I’m buying the “125-100 put spread”) I continue to take the risk that my stock will drop from current levels to 125 within the next year and a half, but I’m protected against declines from 125 to 100, which I consider a significant portion of what would be a “really bad” drawdown for MMM. My goal would be to pay around 5.50 for this put spread, which would either be funded by my MMM dividends by then or by selling the covered call described above.

MMM Put Chain January 2024

Looking for Alpha, January 2024 Options

Option Strategy #3: 1×2 Put Spread

A slightly more aggressive strategy would be to try to do it “no cost” by buying a 125 or 120 put and then selling of them 100 exercise puts, so the two puts I sell cover the cost of the one I buy. This means that I don’t need to pay for protection up front, but it also means that if MMM falls below 100 over the next year and a half, I am not only exposed to the decline in my own shares, but I’ll also have to buy more shares at 100. I would consider this version more aggressive because I would be happy to buy more MMMs at 100, and I would consider that risk an acceptable cost in exchange for modest downside protection.

Conclusion

Despite its recent declines, MMM stock looks more “fair” than “cheap”, and therefore presents shareholders with many challenges associated with owning a good stock with a decent return, but not much in terms of expected growth. . The three options strategies featured above are just a few of the many ways MMM shareholders like me could try to improve returns and fine-tune risk exposure.