Bond-rating agency Moody’s has downgraded the debt of materials giant 3M from A1 to A2. Even though the news caused the company’s stock to drop, investors are already aware of the challenges that led to the rating change.
Moody’s downgraded 3M’s senior unsecured debt to A2 from A1 on Monday afternoon. The A2 rating sits in the middle of Moody’s investment-grade range, and the outlook on 3M’s debt is negative.
3M did not respond to a request for comment, and shares closed slightly lower. However, investors didn’t seem too surprised by the debt downgrade.
Main Contributors to the Rating Downgrade
Moody’s cited legal liabilities relating to chemicals called PFAS and potentially faulty earplugs sold to the military as reasons for the downgrade. PFAS are dangerous substances produced decades ago by 3M and others that have been discovered in groundwater supplies. Recently, 3M agreed to a $12.5 billion settlement for PFAS remediation with public water providers.
Overall, the downgrade reflects Moody’s concern about the impact of these expenses on 3M’s financial position and future earnings.
Moody’s Downgrades 3M’s Credit Rating
Moody’s recently downgraded 3M’s credit rating following the proposed settlement on an important class of PFAS claimants. Though it is a key milestone for 3M, the settlement is expected to constrain cash flow for years to come and increase leverage. Furthermore, future potential settlements related to either PFAS or Combat Arms [earplugs] could further stress 3M’s financial strength.
Moody’s expects that 3M’s debt-to-earnings before interest, taxes, depreciation, and amortization (Ebitda) ratio will go north of three times. This ratio is a common measure of balance sheet strength, and S&P 500 companies typically operate with a ratio below two times. Currently, 3M’s ratio is about 1.6 times.
Legal liabilities have been a significant factor that has weighed heavily on shares for years. In contrast, the S&P 500 has gained about 44%, while 3M stock has slid about 34% over the past three years.
Despite the downgrade, there have not been many changes to 3M bonds. Bond investors are aware of the legal liabilities that come with investing in the company.
Investing in 3M Bonds
A bond from 3M that matures in 2025 is currently offering a yield of about 5.4%. This is a considerable increase from the spread of only 20 basis points over the corresponding treasury yield that it had in late 2020.
If you are looking to invest in bonds, this could be an attractive option given its higher yield. Keep in mind that as with any investment, there is always a degree of risk involved.