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Investors… Applaud… 3M Dividend Cut?

Many dividend cuts are followed by a sharp drop in share price. According to a 2010 study, the average stock that cut its dividend saw a 12% drop in stock price. And dividend cuts by Walgreens Boots Alliance Inc. (WBA) and Leggett & Platt Inc. (LEG) serve as recent reminders of these risks.

But, of course, not all dividend cuts occur due to a slowing underlying business. Some companies cut dividends to invest more in promising projects or following a divestiture that divides their business in multiple parts.

That’s why when 3M (MMM) announced a cut to its long-time dividend, investors applauded the move rather than sending shares lower.

What Happened With 3M?

3M slowly earned its status as a Dividend Aristocrat after consistently hiking its dividend for six decades. But recently, the Post-it Note maker was dethroned.

On April 1, 2024, the company spun out its healthcare business, Solventum (SOLV), retaining a 19.9% ownership stake that it will monetize over the next five years. However, following the spin-off, the company reset its dividend payout to 40% of adjusted free cash flow—a move that would result in a substantial cut to its long-rising dividend.

While a dividend cut was always in the cards, the company hadn’t issued any hard free cash flow guidance and some analysts speculated that the company could cut the dividend even more to account for potential weakness during the second half of the year.

But, on May 14, the company announced a dividend of $0.70 per share, which was higher than some analysts expected—and shares rose more than 5% over the ensuing days.

The move suggests that adjusted free cash flow will come in around $3.87 billion, assuming the dividend reflects 40% of the total value, which is roughly in-line with analyst expectations. However, it’s worth noting that the FactSet adjusted free cash flow consensus had been dropping from $4.08 billion at the end of April.

How It Compares

3M’s recent dividend cut occurred for different reasons than Walgreens or Leggett & Platt, which means its share price could avoid the same downside.

However, even when dividends are cut for financial reasons, it’s often the best move for the business. By reducing dividend outflows, companies can shore up their balance sheet without making potentially risky changes to their existing operations (e.g., by cost-cutting or selling off assets). And in some cases, it could help bring key ratios, like the dividend payout ratio, to sustainable levels.

If the changes leading to the business slowdown are temporary, these companies could also start hiking dividends again in the future from a much healthier baseline.

Recent Dividend Cuts by Long-term Dividend Payers

The list is sorted by the amount of dividend cuts made by these companies. They currently yield between 1.9% and 6.7%, while year to date total return ranges between -8.7% and -60%.

What’s Next?

3M’s dividend cut is somewhat of a non-event due to its underlying cause—investors see no change in the underlying fundamentals.

But its spin-off could present an opportunity.

Several studies have shown that spin-offs and carve-outs outperform the S&P 500 during their first year. That’s because early indiscriminate selling leads to attractive entry points and new management teams typically have large incentives to perform well.

So, 3M investors may be happy with their relatively intact dividend payout. The company appears committed to continuing its long history of dividend payments, with plans to pay out roughly 40% of its adjusted free cash flow moving forward.

At the same time, shareholders may also want to consider holding onto their Solvenum shares, given the strong historical performance of spin-offs.

Both companies are well-positioned to pursue their respective growth and capital allocation plans, creating more aggregate value for shareholders.