3M Bull/Bear Thesis With CashFlow Hunter And Brett Ashcroft Green

Summary:

• CashFlow Hunter runs Catalyst Hedge Investing and is bearish on 3M.
• Brett Ashcroft Green is bullish on the stock.
• Today they discuss their investment thesis.

Listen to the podcast below or on the go via Apple Podcasts or Spotify.

CashFlow Hunter runs Catalyst Hedge Investing and is bearish on 3M (NYSE:MMM). Brett Ashcroft Green is bullish on the stock. Today they discuss their investment thesis.

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Transcript

Rena Sherbill: Okay, CashFlow Hunter and Brett, welcome to Investing Experts Podcast talking 3M. Super happy to have you both on the show and super happy to get this Bull-Bear segment started. So thanks for coming on the show to you both.

Brett Ashcroft Green: Thank you, Rena. I appreciate it.

CashFlow Hunter: My pleasure as always.

RS: Brett, I’d love it if you shared with our audience your journey to investing to Seeking Alpha, what brought you to invest in general and then also to write about investing?

BAG: Sure. So I mean I’ve been involved in finance and real estate for the past, I guess, couple of decades working on the private side of debt financing. And I never worked really on the equity side, so – but it’s always been a personal passion of mine investing in real estate, rental properties, and then into stocks in general.

So as one of the older kind of millennial generation folk, the fire movement is a big thing for us as far as financial independence and retiring early, you can’t work hard forever. So that’s always been – my motivation is just to be frugal, save, invest everything I can, both in rental properties and stocks. And I’ve done well so far, thankfully.

And getting to that point where you start feeling financially independent and getting into Seeking Alpha is – was important, I think, to just kind of express some ideas and being able to use the tool set Seeking Alpha has, everything is really convenient.

I have to say all right there in one spot where I can click on it, cycle through SEC filings, look at kind of the consolidated data for income statements, cash flow statements, balance sheets, and all those things. It’s really cool. And every time I have an idea, if I write an article, a lot of that is me working through my own kind of thought process to see whether or not I want to buy, sell or hold something.

RS: Brett, I’d love to hear from you what your general thesis is on 3M, and maybe if it’s a typical stock that you would be looking at?

BAG: Yes, I mean I’m kind of a person who hunts through companies that display that quality of being good management, combined with a high earnings yield. One of the places that I really like to screen through is Joel Greenblatt’s Magic Formula. So I’m using it for many years. It’s very hard to see a Dividend King actually pop up on there and 3M has been consistently on there when I screened for mid- and large-cap companies.

So that really stood out to me starting going through the screeners looking at it being an all-time dividend – high dividend yield. They’ve been paying dividends for 64 years. We got price-to-book pretty much looking like close to an all-time low. Price-to-earnings, same thing, almost all-time low. We’re looking at – looks like around 2013 prices on the stock. It’s – the litigation issue surrounding 3M is a big deal. It’s creating the opportunity, but I think that the risk reward ratio is leaning more towards being reward than it is for risk at this point.

RS: So CashFlow Hunter, would – what would you say, I guess, is your main thesis? And if you want to counter any of Brett’s initial points, I’m happy for you to include that in there.

CH: I don’t disagree with any of the, what he just stated on the statistics as they are right now. My issue with the company other than – I might disagree with quality of management. I don’t see this business as management has done a spectacular job with really any of their business lines, if you look at revenue growth and returns on invested capital for – going back for the company, none of them are particularly stellar.

But I really care more about what the business line is going to be looking like going forward. And everything I see of this company is that these liabilities they face are massive and are fundamentally going to degrade at the very least the earnings power of the company going forward, if not potentially put it into severe distress.

RS: So, Brett, what would you say to the massive liability issue?

BAG: Yes. I mean, in my article, I kind of tried to comp that out doing, like, a typical Warren Buffett-esque Owner Earnings Model and trying to incorporate about a $1 billion into having liabilities for paying out between the PFAS and also the earplug case. That would be equivalent to about $30 billion, comping it to, like, the Johnson & Johnson (JNJ) case, where it would be put in a trust and then paid out over a 25-year period.

And then taking into consideration, their taxable income is about 20%. I think the net effect would be about a $1 billion a year paying out as far as the reduction what we’re going to see it drop to the bottom line. But also their margins are being compressed right now. I don’t believe because it’s a big management issue.

If we look at the actual cost of revenues for a lot of companies, especially when you’re dealing with raw materials, I mean, in essence, 3M is also a company that deals with petrochemicals, right? And a lot of plastics and such are going to be highly dependent on oil and oil byproducts.

So we’re looking at, let’s see here, before COVID 2018, we have a cost of revenue about 50%, and this jumped up TTM to about 57% or so. So I think with inflation being what it is, a commodity super cycle as that tends to deflate more in the macro perspective of what’s going on, I think that a lot of those problems are going to resolve themselves along with better international relationships, especially in Asia Pacific.

We have Antony Blinken over there trying to make good with Xi Jinping right now, 60% of revenues come from outside the U.S. So it’s not just a U.S. story. And then if we’re looking at interest rates from a macro perspective as well, they state clearly in their 10-K that the strengthening of U.S. dollar is really affecting currency spreads and those kind of things.

So when they’re taking in income from other countries. So as we start to pause rates, lower rates, and our currency is not so hot, I think that’s going to also enhance their margins as well.

RS: And CashFlow Hunter, what would you say to Brett’s bullish take on that?

CH: Well, I have to respectfully disagree on the margin issue. Their margins started degrading in 2019, so that was the year before COVID came along. That’s also the year that their returns on invested capital, their returns on assets, their returns on basically any- any return ratio started declining. So I think it’s very hard to argue that we were in a super cycle either in inflation or in any kind of commodity input or labor cost during that – during 2019.

On top of that, several other competitors who you would argue went through – had basically faced similar margin pressures show no real margin degradation during this time period. Let’s also remember that these guys, they have a healthcare division, which is reportedly, it’s supposed to be a higher-margin business, then there’s just a typical the consumer business or the other two industrial businesses that really ought to be insulating that the other businesses that were experienced those margin issues and it has not.

On top of that, I think that a lot of people do forget or they don’t look at the fact that this is a company that has spent quite a bit of money, net cash on acquisitions over the past 10 years. They did $3 billion worth of acquisitions in 2015. They spent another net billion dollars in acquisitions in 2017, they spent another $5 billion. This is cash they spent on acquisitions in 2019.

And yet EBITDA has not really materially – has not gone off really at all over that time period. EBITDA in 2016 was $8.5 billion. EBITDA in 2022 was $8.5 billion. And last year, it was – on a trailing 12-month basis, I believe it’s– they’ve guided to about $8 billion for this year.

So that doesn’t – if you’ve spent net north of $5 billion on acquisitions in the past 10 years, cash, forget about shares, I don’t think you should be standing in place on an EBITDA basis. And I think that the – on the liability front, if we’re talking that $30 billion, let’s say, that is going to be the ultimate liability split between the two, I don’t think that that is that 30 years is going to be the payout term. I think that’s pretty hopeful and that is a best case scenario.

BAG: Well, I put 20 – I put 25 years kind of as an estimation and then kind of decrease it if it’s $1.2 billion by the tax rate.

CH: Okay. I mean, on a present value basis, there’s not a material difference between 25 years.

BAG: Not much, yes.

CH: So I look at that and I say, okay, well, that is an aspirational time – hopeful liability payout period. First, it seems that the settlement with the multi-district liability case that was negotiated by Chemours (CC)/DuPont (DD), Corteva (CTVA), is that the payment will be made upfront.

So that is – perhaps that’s only about I believe it’s a $1.2 billion split between the three companies, but the – not evenly. But I don’t know why the MDL for lit settlement for 3M, if that – if the payment from Chemours DuPont is going to be upfront why their payment of “at least $10 billion” would not be payable upfront. Although, it’s entirely possible that there could be some sort of payment structure.

The problem with the announcement that they made is that there’s no detail in it. It’s a very odd announcement that you make a detail of – you make – to make an announcement of, oh, we’re – we have a settlement of at least $10 billion. And they don’t say what percentage of the plaintiff base is going to accept it. What the hurdle rate for the plaintiff base to accept it. And because they said they’re opt outs. Well, okay, they’re opt outs.

So that means that the bigger water utilities that are going to afford to pursue a lawsuit on their own won’t continue to do so. And how many of those guys can opt out before the company says, okay, well, we don’t have a settlement.

And then lastly, there was a PFAS Conference last week hosted by Bank of America. And I think it’s important to note, I mean, I knew this before the conference, but I think a lot of other people perhaps didn’t and the conference did a good job elucidating everything about the liabilities was that those – the liability of the MDL settlement of at least $10 billion, again, is really not very much, doesn’t cover very much, it doesn’t cover any of the State’s Attorney General’s liabilities. It doesn’t cover any personal liability – personal injury liability, any personal property liability, and it won’t cover the Superfund Liability that I believe is very likely to come through once the FDA gets, it has this material designation for PFAS in February of 2024 at the latest.

So there you go. And I also – I’m not entirely sure why the earplug liability would be paid out over a significant period of time. If you look at a lot of the payments into trusts that were made by the asbestos manufacturers, those were not paid out over 30 years. Those were paid out into a trust from bankruptcy over time.

If you look at the opioid liabilities, those were not paid out over 30 years. Endo currently is in process of trying to renegotiate its opioid payment liability. It agreed to a $1.5 billion and not Endo (OTC:ENDPQ), Mallinckrodt (MNK) I apologize. Endo had a negotiated settlement of $200 million. But Mallinckrodt had an opioid negotiation that they negotiated with a very large plaintiff base of a $1.5 billion, I believe, and that was going to be paid out over like three or four years. So everything I see said, it points to a much shorter time period.

BAG: Fair points. I mean just quickly, I just don’t think there’s as CashFlow Hunter said, there’s not a whole lot of detail specifically, especially with the PFAS case, except for comps that we have that are much smaller payouts than what’s being tossed around for 3M.

I mean, I don’t want to say it’s hopeful, but I would think at a certain point when you have a company like this, this is so important to not just U.S. industrial infrastructure, but international industrial infrastructure that it becomes a risk to the U.S. economy if you try to say, we want $10 billion upfront, which is something where you could force an entire company to go into reorganization.

But that’s also the perfect bear case for the company is to say, hey, look at the comps. They’re – we look historically a lot of these companies have had to pay out much faster than this amount of time. The reason why I was comping to something totally unrelated in the Johnson & Johnson’s case is because I believe Johnson & Johnson is more of a similar company to 3M being how important they are to the U.S. economy.

I think judges would err on the side of caution because I think they would know what would happen if they really forced a company like 3M to go in and fund some sort of a trust of $10 billion. Let’s even say if it’s all $30 billion, if both cases end up wanting them to fund that trust within a period in less than a decade you could put 3M under. And I don’t think that any judge wants to do that. It’s just a bigger…

CH: I don’t think any judge cares.

BAG: You don’t think any judge cares. I don’t know. If it was California, I would say maybe something. I know that the PFAS is being held in the Northern District of Florida. So I hope that they err on the…

CH: It’s in South Carolina.

BAG: Yes. So I believe that they wouldn’t do that, but that’s just my own personal opinion.

CH: I just look, if you’re looking at history, first of all, I don’t think that the talc settlement for Johnson & Johnson was ever in any risk of ever putting that company into bankruptcy, what did they settle for, $15 billion, $9 billion? I don’t even know. It was – that’s half of what Johnson & Johnson’s EBITDA is every year. And it’s – let me just look at its free cash flow. It’s one year of free cash flow for – if it’s – if the number was $16 billion, that would be less than one year of cash flow for Johnson & Johnson. It’s almost meaningless from that perspective.

BAG: Yes. That’s not the argument though. I’m just saying exactly levered free cash flow for – if you’re talking about for 3M, it was only about 3.5. So it’s a much bigger risk to 3M. Yes, absolutely, it’s a much bigger risk to 3M. So, if Johnson & Johnson even got that kind of a payout structure, I’m just saying, would we want – and I guess your assumption as a judge is historically don’t care about these things.

CH: Yes.

BAG: But is 3M more important to, let’s just say, these are all being held in federal courts, right? Is it – are they more important to the U.S. economy than just to say, should we pay out these litigants as quickly as possible. What would the net effect be to the U.S. economy if – you’re taking out pretty much the widget company that helps everything operate.

CH: Well, I don’t disagree that that PFAS is going to be – is a necessary product for a lot of industries. It really is. It’s very necessary for the production of a lot of integrated circuit boards, a lot of semiconductor design and as maybe as something as broad as you can’t build a nuclear submarine without PFAS. 3M is getting out of the PFAS business.

BAG: Yes, they’re selling that…

CH: No. No, they’re shutting it down. So the argument of, oh, well, if we put 3M out of business on this, then they won’t be making PFAS, and then that’s terrible for the U.S. economy. That doesn’t hold water because they’re already in the process of shutting it down.

If you look at historically, the companies that were in the asbestos liability chain over 70 of them filed for bankruptcy. A lot of them are as pretty well-known companies with an awful lot of employees like Owens Corning (OC). Owens Corning has – currently has 19,000 employees. I don’t know how many of them they had 20 years ago, but they were still – or over 20 years ago. They’re still put in the bankruptcy, Grace, put in the bankruptcy, Johns Manville, put in the bankruptcy, U.S. Gypsum, put into the bankruptcy, and they and it didn’t.

Just because I think there is also this thought that just because a company files for Chapter 11 to have to reorganize its capital structure. And in the case of the asbestos liabilities that it was a way for them to get all of these people suing them into one pool that they can then negotiate into a trust payment.

I do believe that is going to be a similar issue with 3M that these payments are really going to start getting to such a level and – fighting the liabilities in court is going to become such a level that they’re going – they potentially are going to have to file for bankruptcy to get them all into one negotiated pool that they can create a trust for. That does not mean that the jobs at 3M necessarily go away. It doesn’t mean that the products that 3M makes go away. It just means that current 3M shareholders and current 3M bondholders lose out.

The employees, as long as they’re in a business that 3M wants to continue to be in, they still have their jobs. So I don’t think that bankruptcy courts are necessarily in the business of first of all, this is not a bankruptcy court issue. This is a trial judge issue. And the trial judge, I don’t think they would say, oh well, yes, you poisoned a lot of groundwater in a lot of places. So – but we’re not going to really hold you fully responsible because we don’t want to put you in the Chapter 11, I have not seen any instance in the United States where that’s been a restriction.

BAG: Okay. I mean, those are all fair points. That’s part of the risk of 3M, I think, is which side are you on. As far as that’s regarding do you think that those payments upfront are going to end up putting them in the Chapter 11 or do you think they’ll be able to continue on and get a fair payment system to where it’s not going to affect their EBITDA to a great enough extent or affect the dividend, which is the most important thing.

I think those two things would be the most contentious point is that if they – is also if they cut that 64-year streak of dividends, history would tell you, of course, the stock whether or not they stay in business in the current structure that is going to fall. And that’s kind of one of my points as well is that if a dividend were to be cut, that’s usually my only trigger point to be out of something. So…

CH: Well, I had actually written to that point in my case that if the company is intending on spinning off their healthcare division, which it seems like that is their desire.

BAG: Yep.

CH: That the dividend becomes very difficult to support if they do that. The healthcare division is the cash flow engine of the company right now, it’s $2.5 billion of the $8 billion of EBITDA. And let’s assume that that’s a relatively low capital-intense business, so that $2.5 billion of EBITDA is pretty close to $2.5 billion, it’s going to be coming off of operating cash flow, obviously, after tax or pre-tax, tax effect that it’s $2 billion, then the company on a net basis right now is pretty skinny on dividend coverage there. It’s probably right around $4 billion of cash flow between operating cash flow minus CapEx, is that a fair number?

BAG: Yes. So I’m – yes. I mean, I’m looking at the dividend being covered by free cash flow. It’s pretty close like 90%.

CH: Yes. So if $2 billion of operating cash flow comes off, that dividend has to get cut. Now, the dividend could then be paid – the difference in the dividend could then be paid by the spun off healthcare business.

BAG: That’s my assumption. Yes. That would be similar to AT&T.

CH: Right. But do investors look at the two companies and say, oh, like, 3M really cuts my dividend – cut my dividend because I got stuck in this other business that’s now paying me the dividend difference.

BAG: Yes.

CH: I think that organically, that potentially breaks the dividend, which would cause a potential sell off, too.

RS: Do you guys want to talk for investors about the timelines? CashFlow Hunter, I know you run Catalyst Hedge Investing. So in terms of the catalyst or the opposite of the catalyst that may come from the news of settlements or finalizing appeals, can you share with investors how you see the timeline or what you think the timeline is set to be?

CH: Look, it’s unknowable. I – the initial announcement for the settlement was, when it was June 1st or 2nd or something like that, where they said that they had a tentative settlement and they delayed the trial by three weeks, which was supposed to start June 5th. So I would imagine something has to be announced basically this week on the terms of the settlement in terms of – so that’s going to be one catalyst.

In terms of getting the FD – the EPA designation of hazardous material, that is going to be a first quarter 2024 issue, I believe. It could come a little bit earlier, but my sense is all indications are that it’s going to be sometime around then. And when would they have a potential settlement on the earplugs? I don’t know. I think the 3M CEO was supposed to be at the negotiations for – was ordered to be at the negotiations for the settlement with the earplug litigants.

I believe that was June – either June 1st or 2nd or the week before that, the Thursday or Friday before that, I’m losing my dates. When does that come through? That kind of could come through any day now as well. And then what’s the last one? And then it’s really, oh, and then there’s an appellate court that is supposed to decide whether the lower court, which rejected 3M’s petition to bank – file Aearo, the earplug manufacturing subsidiary, into bankruptcy, I would expect that decision to come through sometime before the end of June as well. So there’s quite a bit that could happen at the end of June.

And then the other issues, when do States Attorney Generals that have seemed to have piled on in the recent weeks, when do they start either having negotiated – settlement negotiations with the company and when do those issues start coming to trial? I have no idea.

RS: Brett, what are the points on the horizon that you’re looking for to reinforce your bullish thesis?

BAG: Yes. I mean, I think that’s the timelines that CashFlow Hunter is discussing are sound accurate. However, as someone who would be bullish on the stock, I mean, that’s kind of how we would be sizing our best, I think, is that if there’s a positive piece of news, obviously, throw more money on the pot. If there’s something that looks like it’s going to be more injurious than I originally assumed, then I might hold back.

I personally, again, I’m a long-term investor. I’m not looking to swing trade this thing at all. So, like, I mean, for instance, when I picked up Exxon (XOM) during COVID and it was trading below book value for the first time I ever seen it, dividend on my cost was 10%, it’s a totally different situation in this. I think…

CH: Sorry, which name?

BAG: Exxon.

CH: Oh, yes.

BAG: But yes, I’m just saying, yes, completely different. I understand. I mean, we’re in a situation then oil was trading negative. It was a good opportunity to get in. This is kind of a similar situation. You don’t really get any good opportunities without a lot of negativity surrounding it.

So if it holds to where the total litigation issues surrounding 3M, I think, hold within that scope of $30 billion across the two cases. And if they get some sort of equitable payout structure over a number of years, again, CashFlow Hunter, I understand, you would look at comps and say that’s probably not likely. I would probably think that it would be likely just because I just – I have a hard time believing that the judges are going to want to put them into a reorganization situation, but that’s just my opinion, again…

CH: Yes. I’ve just never – I’ve never seen an instance where that’s been a consideration, really. I just haven’t.

BAG: Yes. I mean I don’t…

CH: J&J was a similar situation at all. But…

BAG: Why was there? Why…

CH: I think it could happen.

BAG: I mean, yes. Why – I’m just saying, why would you think that they would be given such a long payout situation versus other companies that had smaller payouts recently? Talk about recent history.

CH: Yes. Well, we don’t, A, we don’t know what the plaintiffs were demanding. This could be a trust for people who don’t have cancer now, but potentially could have cancer because they use the product. The – all of these water systems that are polluted now need to be cleaned up right now. The money needs to be spent. It may – there will certainly be ongoing costs, but it needs to be spent not over 30 years, that is definitely not going to be the case. I could see it being spent over five or 10 years.

But it’s going to be spent to because these – they have to get their water below four parts per trillion PFAS content to be compliant with the FDA regulations that are almost certain to go into effect in the next couple of months.

So, I can’t speak for what – I don’t know the detail on it and frankly I haven’t looked that carefully at what exactly the plaintiffs were asking for out of J&J and what exactly their cases were. The trust for the asbestos was set up not just to compensate people who had died of asbestos at the time, people who were suffering from this illness from asbestos at the time. But also people who had exposure to asbestos but have not gotten sick yet.

So you can still make asbestos claims against the trust, Now. If you’re – if you’ve recently gotten sick, I mean, Oh, look, a lot of – I know someone unfortunately who died of lung cancer who had worked at an asbestos plant. He died, I want to say sometime around 2009, 2010, and he had spent a summer working on an asbestos plant in the 60s. So it does take a while to – it can take a while to get to come back and bite you. Whereas…

BAG: I guess the question…

CH: …whereas PFAS has to be removed immediately.

BAG: Okay. Okay. I guess the question I pose to you then is as far as the earplug case goes and, okay, let’s say we know it’s around $10 billion for the PFAS case and that the payout is – we’ll call it even shorter, right? Let’s call it five years to fund that entire thing. Do you have any optimistic hopes that the earplug case would be less than $20 billion? What do you think about that case as far as…?

CH: Oh, you think that it would be – it’d be $10 billion for PFAS and $20 billion for the…

BAG: I’m – yes. I’m averaging those two across, exactly.

CH: Oh, I think – then I think you’re way under –way underestimating something. I think on PFAS, this – the PFAS settlement is just one party suing 3M. This is just local water systems, and municipal water system suing 3M. It does not cover State’s Attorney’s Generals that are suing the company for ground pollution and other water. These are water systems. This is drinking water. It doesn’t include really a lot of other liabilities that are out there. It doesn’t include – there’s a – I was watching because when the Maine Attorney General sued the company, there’s a high school that the kids are – can’t play on the field and they can’t drink out of the water fountains. And there’s a nearby farm that the farmer is not allowed to grow – not allowed to raise livestock on because of ground contamination.

There’s going to be personal injury lawsuits. We, three of us, very likely have high levels of PFAS in our blood. And then there is not the – there’s the real headshot and I argued this in my first article about the company. is going, I think, is going to be the EPA getting the hazardous material designation on PFAS, which means that anything – any place that has more than four parts per trillion content of PFAS being ground – just ground contamination, ground water contamination, not drinking water contamination, ground water contamination, that will be designated as a Superfund site, in which case the EPA acts as judge, jury and executioner just says pay us.

So I think that the PFAS settlement that is being – that is – was sort of announced, not really announced. It’s probably only about 20% to 30% of the total liability for PFAS. I think that in a best case scenario from what I’m hearing with the earplugs, that’s going to be about $5 billion liability. So if you ask me what’s the best case for the company?

BAG: Yes. Best case for all – for both cases and your average number of years to pay out.

CH: Best case is, well, I don’t know why the ear people would take a multi-year settlement. These are people who have hearing damage now. If you’re in your 40s and you have hearing damage now, you want to get compensation for it. Now why are you going to wait until you’re 70 to get compensation?

BAG: Well, it seems to me the game they’re kind of playing is that they keep trying to bankrupt Aearo, right? But..

CH: Yes. And that’s why I said the…

BAG: But that enhances the settlement speed though, right? Because, I mean, they see the bills piling up for the defending attorneys, they – class action attorneys are probably going to get paid more than any of the people getting the settlements. So they’re going to see those bills piling up and see their pie shrinking. I think that’s a strategy. I mean, that’s pretty common, right?

CH: No. I think the thing that’s that is – well, yes, that is common, but that that’s not what’s holding up the ultimate settlement right now. I think the company has been filed petition to bankrupt the subsidiary, that was – that motion – when the petition was denied officially by the lower court judge last week, it was really – it started – their first denial was in August of last year. They appealed the decision and there’s in a – it’s currently in front of three appellate court judges, and they should be deciding soon whether they’re going to affirm or dismiss the lower court’s – the lower court decision.

If they affirm it, then the company has the choice to try to appeal it to an en banc decision, which means all of the judges in that circuit, all the appellate judges in that circuit can review the case. But they have to – but the – all of the entire the judge – all of those judges have to agree to hear that appeal. I guess they could also appeal it to the Supreme Court, but I doubt the Supreme Court will hear that case.

So I would expect that if the bankruptcy is denied, which J&J’s bankruptcy was denied, and it was J&J kind of announced the settlement almost right after they got the denial of the – of their petition to bankrupt the subsidiary, I would expect there to be some sort of settlement and I – my sense is that a really good decision would be a – really good settlement for the company would be something like $5 billion or less, and not much less than $5 billion, but that would have to be paid upfront.

I don’t see why – if you have hearing loss because you fired a gun, that doesn’t take 30 years to metastasize in your system, that happens immediately kind of. And you – so I don’t see why anyone would wait 30 years to agree to get compensated for that.

BAG: Yes. But even let’s say it goes over 10 years possibly, right? That’s still, I think, a positive situation for 3M, where they’d be able to maintain their cash flow, their dividend probably, they’re going to have a lot of impairments going forward, too, less tax expense and GAAP earnings are probably going to look shaky if all these things are going on and impairments and such going forward. But I think if they can maintain the cash flow and maintain the dividend, it still remains a very positive story.

CH: But they kind of can’t. I mean, we kind of agree that they can’t maintain the dividend. I mean, 10-year, let’s say they pay $500 million, $5 billion over 10 years, that’s $500 million, $4 million, $400 million after tax, that alone, by the way, brings just that one liability, which is I think a very generous payment stream and a low liability on the earplugs, that alone would make the dividend only barely covered. They wouldn’t be growing it unless they start really achieving organic growth, which as I pointed out, these guys have done north of $5 billion net of acquisitions just in cash over the past couple of years and they still haven’t been able to grow their top line or their margins. And what else?

BAG: My argument was – is that the margins are being influenced heavily by inflation. I think it’ll be seen. Inflation being a big thing, especially if oil prices continue to go down. I’m not a fan. I mean, I’m a fan of oil prices going down. But being Exxon, my number one holding, obviously, that affects that. But if those prices come down of petrochemicals and such, I would predict going forward that their margins would be enhanced just based on that. I mean, it’s…

CH: I don’t know what their – what the percentage exposure is to oil.

BAG: Well, just plastics being a byproduct of oil, right? I mean, that’s…

CH: Yes. I mean, there’s also the argument. I mean, there are a bunch of other companies that are in the plastics business. If we’re headed into recession, which a lot of their performance is already starting to show evidence of that, their numbers are not going to be particularly strong on the top line, maybe their margins improve because of lower oil, which is going to – would be a victim of a recessionary environment, too.

But this is to the extent you’re betting on this company doing well on its – from its – in its cyclical businesses. I think oil prices would come down because we would be entering into some sort of economic slowdown. If we’re entering into some sort of economic slowdown, all the cyclical components of 3M get into trouble. Maybe the healthcare business that has to the extent it has plastics, inputs, maybe it would be a beneficiary, but all the other businesses would suffer.

And one other point I wanted to make, I think, that the equity is an interesting short on 3M. But as I think I believe, Rena and I discussed in one of our interviews, the credit is a just such an easy short because almost, let’s say, they have to pay $5 billion, let’s say, they have to devil’s advocate, they have to pay $5 billion upfront and $10 billion upfront. That’s $15 billion, that’s two turns of EBITDA on their debt levels. All of a sudden their debt goes from 1.5 turns to 3.5 turns.

So at the very least, 3M is no longer a single A rated company. It’s a – it has the credit profile of a BBB rated company, and that wouldn’t be the end of the liabilities. So I think the bonds are just a layup short here.

RS: Brett, is there anything that would happen, I mean, I know that we’ve talked about all of these possible variables. What would prick the balloon of your bullish thesis?

BAG: The only thing that’ll prick it for me is that if that dividend gets cut for a reason other than the spinoff of as CashFlow Hunter mentioned, the healthcare. I can tolerate that if part of the dividend goes to the healthcare. I keep the healthcare spinoff and I have both components. I’m collecting that. I mean, I’m a long-term dividend investor. I don’t long short any of my portfolio. I’m not – I’m just running my own money. I’m not running a fund.

So I’m just looking for opportunities where there’s a very negative situation in, like, a Dow component like this or a Dividend King or a Dividend Aristocrats. These don’t come along very often. And usually, when they do come along, they’re for good reason. So, again, it’s a risk reward thing. If they can maintain their business going forward, they can maintain their – the situation where they have basically an equilibrium between CapEx and depreciation, amortization.

I mean, there’s very few companies if you look through and they’re usually only the Dividend Aristocrats and Kings, where they have an equilibrium between the CapEx ongoing and the depreciation and amortization is kind of like a moat. They have to invest the capital outlay upfront. They only really have to replace the assets that they’re depreciating and amortizing on an ongoing annual basis. A lot of companies have CapEx far exceeding that.

If that changes, too, if I start seeing CapEx far exceeding their D&A, that could put some other thoughts in my head. But as it remains right now, I think, it’s just so undervalued as a stock, as a company. Historically speaking all the ratios, it’s just hard to pass up. I’m that kind of a person. If you call it catching a falling knife, I think that’s fine. But I size my bets accordingly as a certain percentage of my portfolio.

I’m willing to lose a portion of it if I have to. Because, again, the risk reward benefit, I think, the reward is so much greater at this point with this price. That’s just and again, that’s just my opinion. I don’t want to influence too many people on that. I think you probably have a split down the middle at point for the bulls and the bears. So this is not a stock where you would think someone would be irrational for being bearish.

I don’t think that’s the case either. So I really respect CashFlow Hunter’s points. And I I’ve looked at that perspective that this is an existential threat. The litigation issues surrounding 3M is definitely an existential threat. The question in my mind ongoing, especially if I’m comping it to what was happening with Johnson & Johnson is just the fact that this is a Dow constituent. This is a company that’s so important to everything that goes on in the economy that I just think that something equitable is going to happen for this company. That’s my prediction.

And all the ratios and everything on a historical basis are so cheap that that’s the optimist in me and that’s just who I am. I’m a very optimistic person when it comes to investing. I don’t – I’m not, again, as I said, someone who does long, short portfolios. So I’m always looking at the optimistic side of it. But again, if that dividend gets cut, if there’s a lot of negative news that happens with the litigation going forward, I would probably cut my position.

CH: Let me ask you something real quick, Brett.

BAG: Sure.

CH: Are you at all worried that there’s no organic top line revenue growth?

BAG: That I think 3M, me personally, being that I feel that they’re one of those with this company, they grow with inflation, right? And…

CH: Right.

BAG: Right now it’s different though. Right now I think this situation is different because, yes, there’s massive inflation, but this is not one of those kind of, like, ideal goldilocks situations, while shooting for 2% or 4%, et cetera, maybe I guess 2% inflation is ideal, right? So…

CH: Right. But we had – let’s – we can agree that there’s about 8% – there was about 8% inflation last year.

BAG: Yes. It’s been bad. It’s like they’re looking harder.

CH: And they weren’t able to grow or they weren’t able to grow their top line in really any of their businesses in the first quarter, except for the healthcare business, which grew 1%. So I agree with you that it is – it’s a business that should grow the GDP+ type business.

BAG: Yes, yes. Exactly.

CH: So if you have inflationary environment, their – at least, their top line should be growing with inflation, and it didn’t even come close. I mean, a lot of their – the top line of their businesses was negative. I’d also ask, does that perhaps indicate that they are underinvesting in their core businesses? And perhaps that if EBITDA – if CapEx is the same as depreciation and yet you’re not seeing organic revenue growth, perhaps CapEx is too low?

BAG: Well, I would also argue that China has been – I mean, I have strong connections to China. I’ve worked there for a long time and I know the economy very well. They’ve been so shutdown over the last three years, them being open again, and I know just walking the streets of China, I’ve seen several 3M distribution centers and such. That’s a big market. That could have hurt their organic top line growth, just China being shutdown period.

So we’ll see what happens with that. I’m optimistic about that as well and, hopefully, relationships with Asia Pacific, especially China in general getting better. So I’m still an optimist, but you’re right. And if CapEx – if I start observing that CapEx is growing to an extent that it’s really outpacing D&A by, let’s call it a 120%, 130%, that’ll be worrying as well, obviously, right? That’s going to hurt free cash flow.

Just again, I’m just – I’m not even going to bring in the litigation issues and what they’re going to be paying out, but just looking them as a business. They’re – the very typical Dividend King Aristocrat where they have that equilibrium there, they have a brand, but I just think that the rest of the world, especially China coming back to normalcy will enhance their business and their top line.

CH: Yes. I think the one thing I would come back with is a typical dividend aristocrat. Yes. Yes, their depreciation is – usually exceeds capital expenditure. But…

BAG: Yes. It’s close, right?

CH: But there’s also organic revenue growth. And they – there definitely should be some sort of revenue growth organic or just otherwise. If you’ve net spent north of $5 billion just in cash and acquisitions over the past whatever.

BAG: Yes. Well, they’re safety and industrial business, right? I mean, that’s their top revenue generator, right? They’re not the highest-margin business, but that has to do with construction. They’re big into construction. I think construction right now is tough. We know that there’s – that impending commercial…

CH: Well, right now, it’s tough. But, I mean, last year, it was gang – two years ago, it was gangbusters, right? I mean, it was….

BAG: Sure, sure, sure.

CH: I mean, you look at steel prices. Steel prices went bananas.

BAG: Yes. Yes, yes.

CH: You never saw any of that type of growth in 3M.

BAG: True. True. I mean, yes, I see the total safety and industrial business between ‘21, ‘22, basically, receding by about, what is it, about $300 million or so. So…

CH: Yes.

BAG: It’s still, I mean, China, I think that’s going to enhance things. I’m not sure if we’re going to see a recession if we see interest rates kind of start to recede as well. That’ll bring some life back to commercial real estate. So I’m hopeful for those things. I think over time, again, their margins will improve also just from a perspective of inflation not being as hot as it is.

RS: I think this has been a fantastically articulate and well thought out conversation. I have a feeling both of you would agree. I have a feeling that anyone listening to this would agree. I thank you both for contributing to that and diving so deep into 3M and into both of your thesis points. CashFlow Hunter and Brett Ashcroft Green, if you have any final words, otherwise, I really thank you for this conversation.

BAG: Yes. I’d just like to say thank you, CashFlow Hunter for being on here with me having this debate. I mean, especially your knowledge and detail of all the ongoing cases and the history of litigation as it regards to this is great for myself, great for the entire audience. And I enjoy having these debates. And again, I don’t disagree with a lot of your bear historical comparisons here. I’m just the optimist that is looking for the good deals in the falling knives, so.

CH: Yes. I’d echo those points. I always enjoy and appreciate respectful intellectual conversations and no one’s taking anything personally here.

BAG: Absolutely.

RS: Amen.

CH: And I – the only thing I would say is this is not something that I’m like hoping that this company goes down, I’m not a monster. I just – I don’t see how – I think there’s – there are a lot of – there are a lot more risks this company than potential rewards here.

And I also I’d like to reiterate that I don’t think that if a company files for bankruptcy, that’s going to go – the company goes out of business. Again, the jobs are not necessarily lost provided that they’re in businesses and the company wants to stay in and should stay in. This is a reorganization to handle a massive liability impacts bondholders and shareholders. It does not really damage the enterprise per se.

So the company will persist. But if it – we’ll see. Look, a lot – there are a lot of quirks in our legal system. A lot of things that can happen and perhaps I’m wrong. Maybe I’m way too bearish. It’s entirely possible. That’s why I – I’ve sort of spread my bets out between the stock and the bonds, and I – the risk reward on the bonds is significantly better than it is on the stock.

RS: Yes. I think if the past few years have shown us anything, it’s that anything is possible. But I – and like you said, I appreciate informed and respectful conversations, that’s definitely what we’re trying to do here.

Follow Brett Ashcroft Green on Seeking Alpha. Follow CashFlow Hunter on Seeking Alpha. He runs a group called Catalyst Hedge Investing. If you like what you heard here, you can hear a lot more of that. Thank you both for taking the time today. I really appreciate it. Hope to talk to you both soon.

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