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3M (NYSE:MMM) Could Easily Take On More Debt

Editorial Staff by Editorial Staff
November 29, 2021
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3M (NYSE:MMM) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, 3M Company (NYSE:MMM) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is 3M’s Net Debt?

You can click the graphic below for the historical numbers, but it shows that 3M had US$18.2b of debt in September 2021, down from US$19.6b, one year before. However, it also had US$5.73b in cash, and so its net debt is US$12.4b.debt-equity-history-analysis

How Strong Is 3M’s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that 3M had liabilities of US$9.64b due within 12 months and liabilities of US$24.1b due beyond that. Offsetting this, it had US$5.73b in cash and US$4.92b in receivables that were due within 12 months. So it has liabilities totalling US$23.1b more than its cash and near-term receivables, combined.https://d8804cac746313a14d28450365dcf92a.safeframe.googlesyndication.com/safeframe/1-0-38/html/container.html

3M has a very large market capitalization of US$101.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

3M has a low net debt to EBITDA ratio of only 1.2. And its EBIT easily covers its interest expense, being 16.8 times the size. So we’re pretty relaxed about its super-conservative use of debt. Also positive, 3M grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if 3M can strengthen its balance sheet over time.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, 3M recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.

Our View

3M’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. And that’s just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, 3M seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. There’s no doubt that we learn most about debt from the balance sheet. 

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