3M Company's (MMM +1.38%) rich valuation meant that any kind of growth mishap in 2018 was going to hurt the stock, and that's just what happened after the company's recent first-quarter earnings report. That said, after Boeing, 3M Company is the largest industrial company by market cap, and it's often a good idea to buy into a great company after it stumbles momentarily. So is it now time to buy into the Dividend Aristocrat? Here are four reasons to avoid the stock and two reasons to buy it.
Image source: Getty Images.
Valuation still looks expensive
In addition to the drop in 3M's stock price, full-year earnings guidance was also taken down and the forward valuation still isn't compelling. 3M and fellow high-quality multi-industrial company Illinois Tool Works have been treading on historical heady forward earnings multiples recently, and that's still the case now.
MMM EV to EBITDA (Forward) data by YCharts.
Organic growth momentum fading
Speaking at the Bank of America Merrill Lynch Global Industrials Conference at the end of March, COO Mike Roman indicated that 3M's first-quarter organic growth would come in toward the low end of the standing full-year guidance of 3%-5%.
Since then, two things have happened:
- First-quarter organic growth of 2.8% came in below already lowered expectations set by Roman at the conference.
- 3M's full-year organic sales growth range was reduced to 3%-4% from 3%-5% previously.
Concerns over consumer and healthcare segments
Back in spring 2016, management held an investor day and laid out its plan for 2016-2020. Overall organic growth was forecast to be 2%-5% per year. While it's perfectly understandable that the more cyclical of 3M's segments (industrial, electronics and energy, and safety and graphics) suffered during the 2015-2016 U.S. industrial recession, what's more concerning is that 3M's healthcare and consumer segments have consistently underperformed their midterm forecasts.
As you can see below, the consumer segment has only posted one quarter of organic sales growth above its target 2016-2020 range of 3%-5%. Similarly, the healthcare segment has only hit or exceeded its target 4%-6% range in one of its last seven quarters -- that's not the kind of performance you might expect from segments operating in favorable end markets.
Data source: 3M Company presentations. Chart by author.Figures by segment key are 2016-2020 annual growth targets.
3M's growth still relies on volume growth
Management suggested that the weakness in the first-quarter guidance and the reduction in the full-year guidance comes down to weaker-than-expected automotive aftermarket (industrials segment) and oral care (healthcare) related sales -- Danaher Corporation has also seen weakness in its dental segment in the last few years.
These issues are a concern because any weakness in end markets is likely to lead to volume pressure, and as you can see below, 3M has relied on volume increases, rather than price increases, in order to grow sales in the last year or so.
Data source: 3M Company presentations. Chart by author.
Two reasons to buy 3M stock
A glass-half-full perspective sees things in a different way. While it's true that sales and earnings guidance was lowered, the reduction in full-year EPS, from a range of $10.20-$10.70 to a new range of $10.20-$10.55, implies a reduction of less than 1% at the midpoint of guidance. Moreover, it still implies that EPS will grow in the 11%-15% range for the full year.
In addition, management's commentary for the rest of 2018 implies an improvement in 3M's underlying operational performance. For example, CFO Nick Gangestad said that "for the year, we expect price growth to remain strong and that it will more than offset raw material inflation" -- this should help sales growth going forward.
As for valuation, 3M now sports a useful 2.8% dividend yield, and with a 60-year history of increasing dividends and analysts still expecting double-digit earnings growth in the next couple of years, now could be a good time for investors to initiate a long-term holding in this Dividend Aristocrat.
The bottom line
On balance, I think 3M shares are still not quite a good enough value to justify buying yet. The earnings-based valuation still looks a bit high, and we need to see the consumer and healthcare segments growing in line with long-term expectations before feeling fully confident in 3M's prospects. So for now, it's one for the watch list.
