3M Company (MMM) has seen its share price fall even further since the publishing of my last article back in May of 2019, called “3M Company: 3.3%+ Yield On Post-its.” This advertised 3.3% yield has since then improved, standing today at almost 3.82% at the time of writing of this article. Such an improvement in yield and, consequently, drop in valuation and share price warrant a quick update to see if the positive thesis advertised in my initial article still holds.
Short answer – it does.
Let’s see why.
Looking back at 3M – A second-quarter beat and other positive news
On the surface, it seems odd that 3M Company should experience the sort of decline that we’ve seen as of late. The company has been on my buy list for some time, and I’m continuously adding to my growing position, with the clear target of a minimum of 1-2% portfolio allocation (which isn’t bad, considering my entire NA portfolio allocation was < 10% less than 1.5 years ago). Why could it be considered odd?
Well, let’s take a look at the last couple of news items out of 3M.
- 2Q19 earnings beat, with increased sales. Important to note, however, a beat only in relation to expectations, not in actual comparison to YoY numbers. Nonetheless, this caused the company’s share to surge by 5%.
- A matter regarding potentially violating expenditures, which caused some share price slide.
- More than 5000 surgical case lawsuits against the company’s Bair Hugger-system, used to warm patients before and after surgeries, have been dropped following a six-year courtside battle.
- A price target drop from our favorite analyst, Tusa, who now has a PT of $140/share.
- 3M divesting its advanced ballistic protection business to Avon Rubber (OTCPK:AVNBF) for a relatively modest $91M, expected to be EPS-neutral.
So, nothing all that earth-shaking for the company in the past few months. Let’s look a bit deeper into earnings and get a picture of where the troubles for 3M might lie.
2Q19 Report – Some positive points going forward
Perplexingly, and very simply, the earnings call starts with the following slide.
(Source: 2Q19 Earnings Call slides)
Aside from the wording, the presentation style looks remarkably similar to something I did in 4th grade. On a more serious note, here are some of the takeaways considered relevant (and related to the points above).
- Restructuring within 3M is ongoing, with expected savings in 2H19 of $110, as well as an indirect cost reduction of $80M on a YoY-basis.
- A reduced company manufacturing output, reducing inventory levels by $250M on a sequential basis.
- A pre-tax charge of $148M.
- negative organic YoY growth of 0.9%.
- Operating margin drop of 7.8%, also YoY.
- EPS of 2.20/share, down just north of 28% YoY.
Certain segments reported positively – Healthcare/Consumer business among them, with continued headwinds and softness in segments related to more cyclical industrial businesses, such as automotive and electronics. Certain geographies also performed much better than expected, with Latin America/Canada, Brazil and Mexico coming in at low single-digit organic growth.
Also worth noting is that the EPS decline of 2Q19 includes a $0.28/share charge related to the company’s deconsolidation in Venezuela. The absolutely abysmal results, segment-wise, can be easily identified as the Safety & Industrial sales, which not only lost 5% in organic growth but also suffered a 17.4 ppts decline in margins – though the margin decline was primarily related to the divestiture of Communication Markets. Still, sales declined in industrial adhesives, tapes, electrical, abrasives, closures/maskings as well as the automotive aftermarket subsegments.
The company is battling restructuring results while at the same time handling a macro situation rife with headwinds for an industrial cyclical. However, as far as the company is concerned, everything turned out pretty much as they expected it to, and performance was actually better than expected with everything considered – hence the “beat.”
The company also went ahead and affirmed full guidance, with a negative expected organic growth of -1% to + 2% and an adjusted EPS of $9.25/share-9.75/share.
Despite the drops, the RoIC hovers above 20%, with an expectation of up to 22%.
While it would go too far to say it was a “good” quarter, it was definitely more than analysts and investors, including me, might have expected from the company at this point. 3M is preparing for the second half through further lowering of inventories, further cost discipline, flat to low-single-digit growth with a slowly progressing margin improvement as the company focuses on better execution.
The company does expect excellent full-year results in the healthcare business – on the high end of the guidance range, with Consumer somewhere in the middle and Transport/Electronics towards the low end of the range. The company also considers it too early to think of 2020, as this is dependent on the market dynamics/macro, and it could go either way at this stage. However, the company value realization and restructuring efforts will continue into 2020, enabling the company to drive productivity regardless of macro, and improving existing margins sequentially.
So while 3M doesn’t provide any concrete plans for a few of its aims long-term – such as investing in growth, or priority growth programs, the fact remains that 3M is a fundamentally appealing company simply because of its businesses and segments that do work, and more importantly, are patent-protected. 3M can, in my view, be excused to try to buy growth during a challenging time, such as it is doing with Acelity, but as we know from previous M&As, the company-expected synergies very rarely materialize in the exact ways that the merger expects.
Investing in 3M today means that you’re not investing in delivered promises and restructuring, but rather in still-ongoing restructuring, attempts to capitalize on existing businesses/market shares and other ambitions that are in no way yet finished. Take the restructuring of business units, for instance. While those of us versed in logistics, SCM and efficiency analysis can theorize about the improvements the new 4-part structure may have, the company does not exactly go out of its way to explain this to us more than in very opaque, general terms, speaking of “supporting global growth strategy” and “enables better serving global markets.” No, I’m not asking for process flow charts, but perhaps a bit more detail on how things are going to help. There’s a bit of lack of clarity and color here.
However, because of the company we’re talking about and its history and trends, I’m willing to forgive 3M quite a bit when looking at the valuation opportunity here.
(Source: F.A.S.T. Graphs)
3M is a company averaging about 6% earnings growth annually for the past 10 years, while trading at an, in my view, unjustified market premium. While I accept the premium, I wouldn’t invest with the company trading at the premium of ~20 times earnings.
With a valuation shy of 16 times earnings, now things are starting to get really interesting. 3M now yields almost 3.8% per share – and lest we forget, is double-A- rated with a decently conservative payout ratio of barely 55%. It’s also, again historically, outperformed the S&P 500 by a factor of nearly 2X, with more than double the dividends during a time period of 19 years.
I doubt anyone needs to be told that the historical trends for 3M are in the company’s favor. The question is what we can expect going forward. Aside from a crystal ball, we can rely on the FactSet analysts following 3M, which have a flawless track record of predicting 1Y-company results with a 10% margin of error, never having missed the mark for the past decade.
(Source: F.A.S.T. Graphs)
Even just flat development from today’s share price going forward will in the long term provide at least acceptable returns. At returns to premium valuation, we’re actually talking potentially market-beating returns – on 3M Company. One should not invest in 3M expecting exponential growth in the hundreds of percentage points – this is a “safety” placement expected to grow along lines of the market while providing the investor with market-beating amounts of dividends. If it can be bought at times of undervaluation, providing a good opportunity for capital appreciation, so much the better.
That’s where I believe we are today.
The latest drop gives us an opportunity to buy 3M at a valuation, from which I believe it will return in the long term. I don’t mean a few months from now – not a year from now even necessarily, but years. That also means that I don’t consider it unlikely that the stock price could deteriorate further. Perhaps we’ll see the 140 that Tusa has put as his PT. If we do – so much the better! If you believe in 3M being a long-term good investment, how could you not cheer at the investment yielding over 4% at such a time (barring some truly devastating news, of course)?
Overall, there’s very little new under the sun here. The company is delivering on certain targets, but working with most of the other ones. It’s a company still in the midst of a transformative restructuring, and it’ll be some time before the “New” 3M Company comes out at the other end.
Until that time, I’m confident that even in the face of macro headwinds, 3M Management and employees can hold the ship steady and continue performing at the very least on an acceptable level. The dividend is well-covered, profits are “okay” and from what I see, the company is doing everything it can to remain competitive in an increasingly complex world.
And I pose this question to you – Who, at this stage, can ask for more than that?
3M is a “Buy,” and it won’t take much more before I’m willing to increase this to a “Strong Buy.”
Thank you for reading.
At today’s valuation of ~16 times earnings, I consider 3M Company a “Buy.” As always, position sizing is highly recommended to avoid overexposure, and investors should be aware of further potential downside in the company.
Disclosure: I am/we are long MMM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.