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Morningstar | We Slightly Lower Our FVE for 3M After Evaluating the Firm’s PFAS Exposure

After taking a closer look at 3M’s PFAS exposure, we slightly lower our fair value estimate to $187 from $190. The firm’s reserve for PFAS liability currently totals $235 million, which it took in the first quarter of 2019. Importantly, however, that reserve was solely for manufacturing liability that 3M faced directly in some of its facilities; specifically, three sites in the United States and two in Europe. The reserve does not include 3M’s product liability exposure, which we estimate will be much greater and which the reserve does not adequately address.

In our view, 3M’s exposure on the products side is about $3.4 billion in our base scenario. This effect brought down our fair value estimate by $4, offset by a $1 boost from the time value of money. In a bull case, this number falls to $1.8 billion, and in a bear case rises to $7.8 billion. We also amortize this obligation over the course of our explicit forecast (less the final year, which would calculate the value in perpetuity). We adjust these obligations out as part of our adjusted EPS assumptions. Bottom line, we believe a lot of the reaction in the stock price is based on irrational fear that the obligation could total tens of billions of dollars, which we don’t agree with based on available evidence.

We calculate 3M’s exposure based on information from the latest 10-Q filing, first-quarter 2019, including the number of jurisdictions where litigation is pending, as well as our estimate of 3M's total responsibility based on the Minnesota settlement. PFAS, which are a family of manmade fluorinated organic chemicals, have been used since the 1950s for stain-repellent Scotchgard, while the firm also sold its PFAS to other companies to make Teflon and firefighting foams, among other applications. These are strong molecular bonds that are found in the water supply and from our understanding, don’t break down in nature.

3M phased out most of these compounds in 2002, with the remainder in 2009. We assume that the highest concentration of exposure, however, was in 3M’s home state of Minnesota, where it settled with the state’s attorney general for $850 million. From a public policy perspective, we also don’t believe that the extent of settlement mirrors in Minnesota what is found in other states. If the stock price trades down to our 5-star price (about $150), we think the shares would offer an attractive risk/reward for a wide-moat enterprise, provided long-term investors could stomach short-term volatility from hedge fund shorts.