Moody’s downgrades 3M to A1, outlook stable

The downgrade to A1 follows 3M’s announcement of its new five-year plan for the period 2016-2020. The expected increase in debt signals a growing level of financial risk tolerance.

3MMoody’s downgraded the senior unsecured debt rating of 3M Company to A1 from Aa3 and affirmed the company’s P-1 short-term rating. The rating outlook was revised to stable, from negative.

The downgrade follows 3M’s announcement of its new five-year plan for the period 2016-2020, pursuant to which the company expects to continue increasing debt appreciably, to help fund acquisitions and share repurchases. The expected increase in debt of $10 to $15 billion signals a growing level of financial risk tolerance that commenced under the company’s previous five year plan that was announced in 2013. An increase in the company’s dividend pay-out ratio over the last few years and a lower balance of cash and marketable securities also indicate a shift to a comparatively less conservative financial policy. As a result, Moody’s estimates debt/EBITDA to be approximately 2 times in 2017, depending on the allocation of deployable capital between share repurchases and acquisitions over the next two years. This compares to debt/EBITDA of only 1 time in 2013. Similarly, free cash flow/debt is estimated to be less than 15% in 2017, down from 30% in 2013.

3M’s ratings also consider the company’s substantial scale across well-established business positions and a diverse range of markets, as well as the company’s superior operating profitability. Moody’s anticipates EBITA margins to approach 25% in 2016 with further upside potential in subsequent years as the company implements its firm-wide ERP system and optimizes its supply chain and manufacturing footprint. Substantial reinvestment through research and development generates new products and applications, which contributes to organic growth, captures premium pricing and enhances brand values.

The affirmation of the P-1 short-term rating reflects 3M’s strong liquidity profile with sizeable, yet diminished, levels of cash and marketable securities, robust free cash flow and a considerable committed revolving credit facility.

The stable outlook is predicated on Moody’s expectation that 3M will demonstrate organic revenue growth of at least 2%, EBITA margins of around 25% and free cash flow of about $2.5 billion annually. Furthermore, the stable outlook reflects Moody’s anticipation that the increase in financial leverage tapers off under 3M’s new five-year plan.

A rating upgrade could be considered if 3M reverts to its prior, more conservative financial policy pursuant to which share repurchases are predominantly funded with free cash flow, while debt/EBITDA is sustainably maintained at 1.75 times or less and retained cash flow/net debt at more than 30%. A rating downgrade could be considered if EBITA margins decrease towards 20%, possibly as a result of a weakening ability to introduce innovative products. The ratings could also be downgraded if debt/EBITDA is expected to sustainably exceed 2.25 times or if retained cash flow/net debt is expected to approach 20%.

Downgrades:

..Issuer: 3M Company

….Senior Unsecured Regular Bond/Debenture, Downgraded to A1 from Aa3

….Senior Unsecured Medium-Term Note Program, Downgraded to (P)A1 from (P)Aa3

….Senior Unsecured Shelf, Downgraded to (P)A1 from (P)Aa3

Affirmations:

..Issuer: 3M Company

…. Commercial Paper, Affirmed P-1

Outlook Actions:

..Issuer: 3M Company

….Outlook, Changed To Stable From Negative.