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3M's Financials Are Improving. Is That Enough to Save This Dow Stock's 6%-Yielding Dividend?

3M (NYSE: MMM) has faced a lot of challenges over the past few years that have weighed heavily on its share price, which has driven up its dividend yield. At around 6.3%, 3M currently offers one of the highest dividend yields in the venerable Dow Jones Industrial Average.

On the bright side, 3M's financials have started to improve. Here's a look at whether that will be enough to save the Dow stock from cutting its big-time dividend.

A year of improvement

3M recently reported its fourth-quarter and full-year results for 2023. "The fourth quarter capped a strong year for 3M," said CEO Mike Roman in the earnings press release. He pointed out that the industrial giant "executed our priorities and delivered on our commitments -- including expanding underlying operating margins and cash flow."

These improvements were evident in the fourth quarter. 3M's adjusted operating income margin was 20.9%, an expansion from 19.1% in the year-ago period. That helped boost its adjusted earnings per share, which came in at $2.42 per share in the quarter, up from $2.18 in the fourth quarter of 2022.

Meanwhile, 3M produced $2 billion of adjusted free cash flow in the fourth quarter (up 18% year-over-year), pushing its full-year total to $6.3 billion (a 30% year-over-year increase). That gave the company enough cash to fund its dividend ($3.3 billion) with room to spare. It used that excess cash to help strengthen its balance sheet. Net debt declined by 17% to $10 billion.

Is the dividend safe?

The improvement in the company's 2023 financial results and metrics seem to suggest that its dividend is on a firmer foundation. However, 3M's rising dividend yield indicates that the market doesn't believe the industrial giant can sustain its current level.

One factor driving that view is the company's rather muted outlook for 2024. 3M expects its adjusted earnings to be between $9.35 and $9.75 per share. While that would be up from the $9.24 per share it earned last year, it's well below the $9.90 analysts initially anticipated for this year. It's worth noting that 3M is typically conservative (its initial 2023 guidance was that it would earn $8.75 per share).

On a more positive note, 3M expects to generate $4.9 billion to $5.7 billion in adjusted free cash flow this year, likely putting it ahead of analysts' expectations for $4.9 billion. Given its current dividend outlay of $3.3 billion annually, it appears poised to produce plenty of cash to cover that payout.

However, 3M's guidance includes its healthcare division and excludes the potential impact of payments to satisfy some of its legal claims. The company is working to spin off its healthcare unit into an independent publicly traded company (Solventum), which it hopes to complete in the first half of this year. It's also working to finalize its public water supplier and Combat Arms legal settlements.

These items will impact its earnings and cash flow in 2024 and beyond. While 3M will receive a one-time dividend from Solventum to help fund its legal claims (and will retain a 19.7% equity stake that it can monetize in the future), it will lose a portion of the associated earnings and cash flow generated by that business. Meanwhile, it plans to fund some of its legal claims with debt, which will impact its balance sheet and cash flow as it pays interest on that debt.

These uncertainties suggest the dividend remains at risk. 3M could opt to reset its payment level following the Solventum spinoff to realign its dividend payout ratio to its future projected cash flows.

Wait for more clarity before buying for income

3M's financials improved last year, which seemed to put its dividend on a firmer foundation. However, there are lots of moving parts with its pending legal settlements and healthcare spinoff. Given the uncertainty around those factors, income-focused investors might want to wait for the dust to settle before buying 3M for its dividend since risks remain that it could reduce its payout.

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Matthew DiLallo has positions in 3M. The Motley Fool recommends 3M. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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