I came across 3M India while looking for good stock picks. They seem to be financially quite solid and yet their stock price is very near levels they already achieved by April 2016. This led to me look into the reasons for this and I found a few interesting points.
3M is a well-known brand globally across several consumer and industrial spheres. They operate in India with a listed subsidiary in which 3M USA holds 75%. Foreign Portfolio Investors hold close to 10% and the rest is held by domestic institutions and the public. The financials of this company are strong and growing significantly each year.
They don’t pay dividends. None at all.
The noteable thing is they don’t pay dividends. This is not a one-off. As far as I could analyze, they have never paid dividends in any year. Quoting from their 2016-17 Annual Report:
A healthy cash position in a high interest economy is seen as prudent and necessary to fund growth. The Company remains bullish on investments and growth expectations in India, and anticipates substantial manpower, CAPEX and promotional investments required to support growth aspirations. The Company is focused on its growth plan with a long term objective and is in the process of implementing a number of initiatives and projects. As a result, it has been decided to conserve and retain the earnings and, therefore, not propose dividend or transfer any amounts to reserves.
Their net income (profit) in the Financial Year ending 31st March was INR 2,383 Million (approximately USD 36 Million).
Question 1: Do they actually need to retain all this money?
3M India has no outstanding long or short term debt with a small working capital component of INR 46 Million. They had a cash and cash equivalents balance of INR 3,708 Million as on 31st March 2016. This has swelled to INR 7,442 Million as on 31st March 2017. No less than INR 5,900 Million is now held in deposit accounts as on 31st March 2017 which is more than double the previous year balance of INR 2,860 Million. Through the year, the company earned INR 259 Million in interest.
If we make a rough calculation that the average deposit balance in the year was an average of the balance as on end of FY 2016 vs end of FY 2017, the return is merely 5.9%.
During the year, the investments made by 3M India seems to be only INR 141 Million under the head – “purchase of property, plant and equipment and intangible assets” – which is much lower than the hit taken due to depreciation and amortisation which was INR 467 Million. Further, they clearly mention that capital investments during the year were at INR 138 Million (INR 106 Million in 2015-16).
So in summary, their entire capital investment needs for two full financial years could be covered by just the interest they earned from cash deposits in this year.
The operational expenses on manpower and “other expenses” which probably include promotions grew by INR 749 Million year-over-year but this was amply covered for by growth in revenue (their margins have been steady) and hence cannot be a reason to hold back a lot of cash.
So no, they don’t need the money.
Question 2: How do the promoters get a return on their investment?
So you might be thinking, what does 3M USA get out of all this since there are no dividends. So we start examining whether 3M India has made payments to 3M USA. Here is a summary:
3M India was to receive from 3M USA a sum of INR 1,085 Million by performing contract research, sale of goods and re-charge of expenses.
3M USA was to receive from 3M India a sum of INR 9,769 Million out of which INR 8,150 Million was due to purchase of materials. This leaves a sum INR 390 Million in royalties and INR 1,167 Million as “Corporate Management Fee” that 3M India paid 3M USA. These two heads are together equivalent to a full 65% of 3M India’s reported net profits.
Without these items, the “presumed” profit grows to INR 3,940 Million. So this indicates that the royalty is computed as a full 10% of this figure. This is somewhat justifiable given the product research done by 3M USA that 3M India would be leveraging but seems on the higher side.
The “Corporate Management Fee” on the other hand, seems to be the equivalent of a promoter dividend since 3M India has a well-qualified management team and it is unclear what value 3M USA adds here. The fee takes away another 30% of the “presumed” profit of INR 3,940 Million!
Upon closer reading a few of these items like leveraging corporate processes and IT systems from 3M USA do make sense but others do not. Also the quantum of this payout seems absurdly high!
So 3M USA has basically taken out 40% of the profits under these 2 heads!
Given they have more than enough cash stowed away and they pay out 40% of the presumed net profit to the promoters it is unjustified for common shareholders to swallow their commentary on why they need to retain all their earnings.
Question 3: Why do minority shareholders keep quiet?
It looks like 3M India addressed 57 shareholders complaints in 2016-17. This is not a low number. I doubt investors are keeping quiet. However the biggest minority block are FPIs for whom the 6% interest earnings on cash deposit is not bad compared to returns across the globe.
It is unlikely that 3M India will hear these voices given the degree of management control they have. There is also no scope of a buy-back given the promoter holding of 75%.
What would an investor like them to do?
With a presumed profit of INR 3,940 Million:
- they could continue paying the 10% royalty (although a decrease could be called for)
- completely remove the “Corporate Management Fee”
- pay a special dividend to bring out money from bank deposits
- pay a post tax dividend of INR 1,556 Million which would compensate 3M USA for the loss of the above fee but also reward common shareholders
What should an investor do?
- Raise a complaint with them
- Attend their AGMs and vote against the current royalty and fee structure.
- Complain to SEBI
Note 1: All numbers are quoted from the Annual Report for 2016-17 published on their website. I am happy to correct any numbers that are incorrect.
Note 2: Updated with breakup of corporate management fee on 20th Oct 2017.
Disclaimer: I don’t know if 3M India is the norm (likely) or the exception. I have not checked if other listed subsidiaries of MNCs in India also do this. But other companies doing this should not be a reason for 3M to do the same.