MMM

This Ultra-High-Yield Dividend Stock Is About to Lose Its Crown

3M (NYSE: MMM) has been a dividend stalwart. The industrial conglomerate has paid dividends to its shareholders for over a century without interruption and has raised its payout annually for more than 60 straight years. The company's dividend-growth streak currently qualifies it as a Dividend King, a term for companies that have increased their payouts for at least 50 years in a row.

However, 3M is about to make a big change to its dividend policy, which will see it give up its crown. The company plans to reset its dividend now that it has completed the spin-off of its former healthcare business, Solventum. As a result, the company's dividend, which currently yields 6.3%, is about to head a lot lower.

The great reset is near

3M recently reported its first-quarter results, which was its first report since spinning off Solventum. Included in that report was an update to its 2024 guidance to reflect the expected earnings of the go-forward business. The forecast puts its adjusted earnings between $6.80 and $7.30 per share. That's down from $9.24 per share in 2023, due largely to the loss of Solventum's earnings.

Given that range, 3M can't comfortably afford to continue paying its current annualized-dividend rate of $6.04 per share. While the company hasn't announced the reset rate yet (it will likely do that later this month), it provided a framework. It plans to have a dividend-payout ratio of 40% of its adjusted free cash flow following the Solventum spin-off.

That policy has big implications for the dividend. Barron's recently did a little back-of-the-envelope math on what this ratio means for the payout. The company's guidance implies its 2024 adjusted free cash flow will be around $4 billion. Apply a 40% payout rate, and the company would make $1.6 billion of annual-dividend payments, which works out to around $2.85 per share. That suggests 3M would cut its dividend by over 50% from the recent level. This reset would drive its dividend yield into the 3% range. While that's a significant change for existing investors, it's still double the broader market (the S&P 500's current yield is 1.4%) and is in line with the yields of other large blue chip dividend stocks.

Resetting to repair the financial foundation

3M isn't resetting the dividend solely because it spun off Solventum. The company has been battling legal issues related to water pollution and potentially faulty earplugs sold to the military. It agreed to settle those matters last year for a total of $18 billion that it will pay out over several years.

While the settlement structures will help lessen the impact of those costs, the company needs to bolster its financial flexibility so its legal liabilities won't harm its balance sheet or impact its ability to grow. It will now retain 60% of its adjusted free cash flow, increasing its financial flexibility. On a positive note, the company started from a strong position (it has A-rated credit) that has improved over the past year. 3M's net debt was down 13% year over year in the first quarter to $10.4 billion.

The company can also use its retained cash to make new growth investments. 3M's legacy businesses have struggled to grow in recent years. Even after stripping out the impact of Solventum, adjusted organic-sales growth will only be flat to up to 2% this year. It could potentially reinvigorate sales growth by reinvesting more of its retained earnings into expansion initiatives, including mergers and acquisitions (M&A).

3M's reign as an elite dividend stock is nearing an end

3M confirmed it will be resetting its dividend following the spin-off of Solventum. While that's a disappointment for long-term dividend investors, it's no surprise since its healthcare business was a meaningful contributor to its cash flow. On top of that, the company has to fund its large legal settlements and address its sluggish growth. The move could end up being a net positive over the long term because it could free up cash it could use to reinvigorate its growth.

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Matt DiLallo has positions in 3M and Solventum. The Motley Fool recommends 3M and Solventum. 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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