NNDNF - How To Replace 3M Company In Your Portfolio

Summary

• I recently wrote a bearish article on 3M due to the many red flags that may lead to loss of capital.
• However, many investors look to 3M for a few key reasons, and these may lead to stubbornly holding on to the underperforming asset.
• It is easy for me to recommend a sell, but now I will offer replacements that offer comparable attributes to why investors choose 3M in the first place.

Introduction

Most investors hold on to 3M ( MMM ) in the hopes of an ever-increasing dividend. They rely on the company’s stable nature and conservative financial practices to slowly grow their capital over a long time. Some even rely on the relatively high yield of the asset, with the dividend typically hovering between 2% and 3%. However, I believe that 3M is set to either reduce their dividend or stop increasing it as numerous issues arise.

Predominantly, 3M faces significant headwinds in regards to litigation, lawsuits and remediation for both earplugs and forever chemicals. Due to the company’s weakness I believe it would be best to sell. I summarized my thoughts in this article a few days ago.

To complement my prior article, I will now do my best to offer replacements for investors to gain exposure to what makes 3M attractive, but do not offer the same risk of underperformance. Of course, due to 3M’s age, size, and capabilities, there is no direct replacement, so I will provide a few options targeting key investment themes: safety, high yield, moat in product offering markets or innovation, conservative financial management, and dividend growth.

3M - Diversification King

As a diversified industrial conglomerate focusing on materials science, 3M has exposure to most areas of the market. Many investors may be most familiar with their consumer products, often seen at hardware or home improvement stores, but 3M is far more than that. Also, don’t forget that 3M will be splitting off the health care segment, so the story will change soon. Depending on the exact split details, I would consider the health care segment as a potential asset to hold on to, as long as the risks of litigation remain with the core parent company.

So what exactly should we look for to replace 3M? Based on the company’s recent financials, we can see the most weakness involves their consumer segment that offers the lowest margins and negative growth. At the same time, we can see that Health Care is the strongest segment with almost 5% growth and the highest margins. Then, the industrial and materials segments come in the middle of the road, but having the highest moat in terms of capabilities. However, tracing back years we can see that growth is quite volatile between units, and there is no one flagship sector to derive growth (see images below).

No Single Way to Replace 3M

While I find it is easy to replace the health care (Johnson & Johnson ( JNJ ), Procter & Gamble ( PG ), Pfizer ( PFE ), etc.) or consumer segments (the retailers Home Depot ( HD ), Lowe's ( LOW ), etc.), the difficulty will be with the other two segments. Where can we find the equivalent amount of diversification? The first place we should look is beyond the risk of individual holdings (especially if safety is what you are looking for). As Investopedia puts it:

Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk.

One of the main issues for investors with selling 3M is that replacements will be multiple assets. While this certainly diversifies the portfolio and provides further margin of safety, I am sure some investors do not have the time to research additional tickers. If you fall in this category, perhaps it would be better if you went with ETFs or other funds. The diversification of assets beyond 3M will reduce volatility and performance will fall in line with the market. As the adage goes, “whatever helps you sleep at night”, and 3M sets a low long-term growth and return bar to meet.

The most common ETFs that are sufficiently diversified into non-volatile assets are as follows: Vanguard Value ETF ( VTV ) and Schwab U.S. Dividend Equity ETF ( SCHD ). Both hold a wide range of the largest companies in the market, and both trade in a similar pattern. 3M has not traded in line with these two ETFs and has instead underperformed the past year. 3M’s volatility does allow for small periods of out-performance, but shareholders would have needed to buy in 2000 to have returns equal both VTV and SCHD upon their inception (2000s and early 2010s, respectively). See charts below for clarity, and not how important it is to manage volatility.

Beyond diversification, another one of 3M’s calling cards is offering dividend growth. A few equity ETFs offer higher yields than 3M typically does, between 2 and 3%. If dividend income is all you are looking for, then there are many other replacements. Four high yielding ETFs, ranging between 4 and 8% on average, are as follows: the iShares Core High Dividend ETF ( HDV ), the SPDR Bloomberg Barclays High Yield Bond ETF ( JNK ), the iShares International Select Dividend ETF ( IDV ), and the Nuveen Preferred & Income Securities Fund ( JPS ).

While the recent sell-off allows 3M to have an enticing yield currently, the company’s total return is almost in line with these high yielding funds over the past five years. The underperformance over the past five years has caused 3M to perform worse than junk bonds. Due to the risks, I would believe investors are best served to search for yield beyond 3M. The dividend yields and total returns of each ticker is summarized in the two charts below (do note the two different color schemes for each chart).

Individual Companies

Have a stubborn desire to trade individual companies, rather than funds? This section of the article is for you. While I addressed the fact that 3M has no direct replacement in a similar company, there are motifs we can track, similar to the diversified and high yielding funds. I will start by looking at the conglomerates. Then, I will focus on individual companies that may be competitors in 3M’s broad revenue segments, often major competitors. “The enemy of my enemy is my friend”, as the saying goes.

Honestly, if you like 3M, then you might not like Berkshire Hathaway (BRK.A) (BRK.B) (no dividend), but as usual Buffett’s company continues to trundle along. Add in a high yield ETF I discussed earlier, then you get an equal amount of yield over time. You could also take the chance on Icahn Enterprises and enjoy the 15% average yield. Don’t be scared by the K-1 and activism-based business style, total returns are in line with the market, if not more. Use the excess cash to pay for a tax advisor. Those are the only two steadily performing conglomerates, so I think they are the only ones worth a thought (Honeywell ( HON ) is too expensive, others have growth issues, etc.).

3M Has Innovation and Product Moats, Others Do Too

The last set of companies I will address are those more tailored towards diverse materials science offerings, similar to 3M’s core segments. These investments are more growth oriented and do not offer high yield, but do offer the opportunity for solid capital gains. This is thanks to multiple factors, but the primary reason is via a moat on their prospective segments.

3M is not the only materials developer, and as I addressed in my main article, R&D spending is not increasing. As such, this leaves the door open for competitors to gain market share, and may be a major reason for the stalling growth over the past few years. Although 3M has a high dividend and conservative balance sheet. The following three companies offer just that and more: growth, innovation, and great financials.

Specialty Chemicals:

First up is Ashland, Inc. ( ASH ), a conglomerate in specialty chemicals that develops a wide range of precursory materials for manufacturers across a wide range of industries. The company has gone through a very successful revitalization program over the past 10 years, and although revenue growth is negative, the shares are trading around all-time-highs. 3M could copy Ashland’s pattern of selling off lagging assets and investing in higher margin products, but I have not seen this occurring on a large scale for 3M. See my recent article on Ashland for more details.

Adhesives, Coatings, and Material Science:

Another well-diversified company focusing on specialty industrial machinery to apply adhesives, coatings, and more is Nordson ( NDSN ). While diverse in applications, the company has strong moats in their niche use-cases, and this has provided a strong financial profile over the past two decades. I believe most 3M investors would agree that Nordson offers better financial offering than 3M, even if the company is far smaller. Just look at those 58 years of annual dividend increases!

A recently announced acquisition of CyberOptics, which I discussed in an article , adds exposure to the semiconductor manufacturing industry. With a focus on profitability and strong customer value, growth is not extreme but performance exceeds 3M. While the valuation is certainly at a high point, those with a long-term mindset and desire for steady earnings growth will certainly be happy in the future.

Industrial Components:

The last company that offers diverse, moat-like business exposure is Nidec Corp ( NJDCY ). Nidec offers an extremely large moat in the electric motors industry, an incredibly important field across a wide range of applications. While 3M is not a machine manufacturer, the company's single use products and materials are utilized across most industries, and having that broad exposure is beneficial.

Nidec's main risk is due to the fact that the company now is a leader in building third-party electric vehicle drivetrain components. This has increased share price volatility and may dissuade some from investing. However, the financials remain strong, albeit more focused on high revenue growth rather than earnings growth (sub-1% dividend here). I offered Nidec as a replacement for General Electric shareholders , and I will continue to do so for 3M investors as well.

I know many 3M investors are not in fact retirees, but are actually young dividend growth seekers, and that gives the advantage of a long investment horizon. Although dividend growth is not the only means to a wealthy future, and 3M certainly is not the best option for that path, the choice is yours. With Nidec’s $30 billion market cap, but 10% revenue and 13% earnings per share 10-year annual growth rates, there is plenty of room down the road for the company to drive margin expansion on returns. The EV industry is just being established, and based on Nidec’s recent partnership with FREYR Battery ( FREY ), there is plenty of potential.

Relative Performance

Some 3M investors may be worried that these higher growth companies are riskier and not worth investing in. However, as the data shows, all three companies are offering a total return above 3M over the past 10 years. Even if only looking at the recent highs made by 3M in 2021, 3M was the underperformer. The high dividend yield is not a major point of consideration, especially since these failed to drive the total return. Also, when times are good for 3M, the dividend yield is not huge at only 2%, when the other assets are between 0.5 and 1.5%. However, volatility is higher in these assets, so combining the investment with the safety holdings I addressed above will help offset that risk.

Conclusion

While I personally find that 3M can be replaced easily with other assets, I do compliment the company’s difficulty in finding a single replacement. As I am young I am biased towards total return metrics and long-term recurring investments regardless of valuation. As such, I will always find the three replacement stocks I covered last to be the best choices. However, I hope my coverage of safety and high yielding assets was also valuable for those looking to maintain capital and earn significant income. There is no correct option, whatever suits an individual’s needs.

Another idea could be to continue adding 3M, even considering the significant risks, and increase investments in the other tickers I address in this article. As a contrarian play, 3M offers significant risk/reward, but having a fallback plan is a way to play both sides of the coin. While I personally believe that the risk may be pervasive and lasting, I cannot fault those ready to wait up to decades for some form of rebound. It is, however, important to consider all options carefully and I will stick to my upside risk choices being speculative growth plays rather than waiting for 3M’s stars aligning.

Thanks for reading. Feel free to share your own replacements below.

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