uploads/2016/06/part-21-1.jpg

Why You Should Expect 3M to Persist with Its Share Buybacks

By

Updated

Dividends and share repurchases

3M Company (MMM) has an ongoing streak of 58 years of dividend increases. It has paid dividends without interruption for the last 99 years. In the five-year period between 2011 and 2015, 3M’s dividend per share rose from $2.2 to $4.1 at a compound annual growth rate (or CAGR) of 13.3%.

Between 2011 and 2015, the company’s dividend payout ratio has risen from 36.3% to 54%. The dividend payout ratio increased from 45% in 2014 to 54% in 2015 due to a 20% rise in its dividend per share when earnings per share had risen by just 3%. Based on its current payout ratio, 3M’s dividend payments are likely to be sustainable.

Article continues below advertisement

Share buybacks

In February 2016, 3M outlined a plan to repurchase $10 billion worth of its stock. The new buyback program replaced the company’s $12 billion buyback plan that had been authorized in February 2014, of which only $1.5 billion was left to be repurchased by the end of 2015.

3M repurchased roughly $5.2 billion worth of its shares in 2015. Since 2005, 3M has returned $46 billion in dividends and share repurchases.

To understand whether the company’s share buybacks are sustainable in the long run, we’ll be looking into its FCFE (free cash flow-to-equity) coverage ratio. An FCFE ratio of below 1 is considered unsustainable. Read on to know why.

Free cash flow coverage ratio

FCFE is the cash flow available for distribution to shareholders after accounting for debt borrowings and payments and fixed and working capital investments. The FCFE coverage ratio is calculated by dividing FCFE by the sum of dividends paid and the dollar amount of share repurchases. Therefore, the ratio considers not only dividends but also share buybacks.

3M’s FCFEs were $4.2 billion, $6.3 billion, and $8.5 billion in 2013, 2014, and 2015, respectively. As seen in the above chart, 3M’s FCFE coverage ratio has remained largely stable, except for in 2014 when it fell below 1.

An FCFE coverage ratio of 1.08 indicates that the company has enough reserves to make dividend payments and share repurchases. Therefore, we don’t see any threat to shareholders’ being rewarded by 3M through dividends and share buybacks.

Key ETFs

Investors interested in trading in the industrials space can look into the Vanguard Industrials ETF (VIS) and the Industrial Select Sector SPDR ETF (XLI).

Major holdings in VIS include General Electric (GE) with a weight of 12.2%, 3M Company with a weight of 4.3%, and United Technologies (UTX) with a weight of 3.7%.

Advertisement

More From Market Realist