The risks of a 3M dividend reduction are high
This year marked the end of an era for Walgreens Boots Alliance (NASDAQ: WBA). The pharmacy and retail giant slashed its dividend by 48% to start this year, ending a streak of 47 straight years of increases. Before that reduction, the company had one of the highest dividend yields in the S&P 500 at around 7.5%.
Walgreens' decision to throw in the towel on its long-standing dividend growth streak might make 3M (NYSE: MMM) investors nervous. The industrial giant also pays a big-time dividend (currently yielding 5.7%) that it has grown for more than 60 consecutive years. Here's a look at the likelihood that 3M's payout will face the same fate as Walgreens' dividend in 2024.
A look at what doomed Walgreens' dividend
Walgreens' financial situation has deteriorated in recent years. During its last fiscal year, the company's earnings per share declined more than 20%. Meanwhile, its operational cash flow slumped by over $1.6 billion to less than $2.3 billion. That left it with only $665 million in free cash flow after funding its capital spending ($1.5 billion less than the prior fiscal year).
Walgreens' financial issues led the company to take additional action to shore up its cash flow and balance sheet in 2024 by slashing its dividend. The move will save the company $800 million annually, which it can use to fund growth capital investments and repay debt. The company also plans to reduce capital expenses by around $600 million while targeting about $1 billion in operational cost savings to further improve its financial situation.
Is 3M in a similar predicament?
3M's high-yielding payout suggests it's also at risk of a reduction. The main factor causing concern is the company's legal issues. It has been working to settle litigation claims brought against the company regarding earplugs sold to the military and "forever chemicals" that the EPA has designated as hazardous.
The company reached settlements in both cases last year. It agreed to pay up to $6 billion to settle the Combat Arms earplugs litigation and $10.3 billion for claims relating to the forever chemicals. It will pay these settlements over many years.
On the one hand, the settlements provided clarity on its future liabilities. However, credit rating agencies deemed them to be negative. S&P Global cut its rating on 3M's credit to BBB+, three levels above junk, while Moody's maintained its A2 rating with a negative outlook on its credit.
Meanwhile, 3M's financial results have started improving over the past year. Its adjusted free cash flow was up 37% to $4.3 billion through the third quarter of last year. That was enough to cover its $2.5 billion in dividend payments, with room to spare. 3M used that excess cash to strengthen its balance sheet. Net debt has declined by 11% over the past year to $10.8 billion.
These factors all seem to suggest that 3M should be able to maintain its dividend, if not continue to increase the payout. However, that doesn't mean the dividend is safe. A potential catalyst for a cut is the company's upcoming spinoff of its healthcare unit as an independent public company.
On the one hand, 3M expects to receive a $1 billion cash dividend from that entity following the spinoff to help cover its legal settlements. However, the unit generated $8.4 billion in annual sales in 2022 (about a quarter of its total). Because it's such a meaningful contributor, 3M may opt to reset its dividend following the spinoff to reflect its reduced earnings profile and retain more cash to fund its legal liabilities.
The risks of a reduction are high
On balance, 3M is in a better financial position than Walgreens. It generates more than enough free cash flow to cover its dividend and has a higher credit rating. However, given the company's legal liabilities and upcoming spinoff, its dividend could still face the same fate. Because of that, income investors need to prepare themselves for a potential cut, which could come this year following the spinoff of its healthcare unit.
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