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3M Is Starting to Look Like a Good Value

By Lee Samaha – Jun 2, 2020 at 10:31AM

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CEO Mike Roman is quietly reshaping the company in the middle of a very difficult year.

3M's (MMM 1.66%) chief executive officer Mike Roman gave a presentation at a Bernstein investment conference at the end of May and what he had to say helped confirm 3M's status as one of the most interesting investment opportunities in the industrial sector.

It's not that the company's operational performance has been great over the last few years, or that its end markets overall aren't being hit by the COVID-19 pandemic. Instead, the case for buying 3M stock is based on the idea that Roman can significantly improve performance in a company that is now valued lower than its peers. Here's the why and how.

A burlap bag with a money sign on it next to stacks of gold coins.

Image source: Getty Images.

3M's star has fallen

3M has gone from being valued at a premium to its peer group to ranking toward the bottom on a free cash flow basis. Yet the company sports a useful 3.7% dividend yield and, having raised its dividend for the last 62 years, it's a prominent Dividend King

MMM Price to Free Cash Flow Chart

Data by YCharts

That said, 3M's relatively low rating exists for a reason. Simply put, the company has recently failed to hit its own earnings guidance, and appears to have lost some of its traditional pricing power. Moreover, it's seen some notably underwhelming performance in its healthcare and consumer segments -- doubly disappointing as these are supposed to be its more defensively aligned segments. 

A transformational year

In response to these failures, Roman decided to take action. This year was supposed to be a year of transition, in which 3M's management would set about realigning the business and restructuring the portfolio. Cost cuts would be initiated, underperforming businesses sold, investments in growth would be prioritized, a wide-scale enterprise resource planning (ERP) rollout would take place, and business groups would be run on a global basis instead of a country basis.

Meanwhile, 3M would be busy integrating the $1 billion acquisition of M*Modal's technology business (artificial intelligence systems for healthcare physicians) and the $6.7 billion acquisition of Acelity (advanced wound care). Both deals were completed in 2019 and were intended to revamp 3M's healthcare segment.

Unfortunately, the COVID-19 pandemic came along, and its impact on 3M's end markets is likely to cloud the optics around the operational improvements management and investors were hoping would become apparent in 2020.

Promises made

All of that said, there's reason to believe that 3M is making progress. Roman's presentation helped highlight a few key arguments in favor of the stock:

  • The restructuring and transformational initiatives are ongoing.
  • Actions taken to realign the businesses are already bearing fruit.
  • 3M's production footprint leaves it well placed to deal with a potential shift in manufacturing activity as a consequence of the coronavirus crisis.

For examples of the first two points, Roman highlighted the completion of the $650 million sale of its underperforming drug delivery business. He also discussed how closer integration between 3M's supply chain and customer operations "has been a tailwind for us in the middle of the fight with COVID."

The third point is particularly interesting and may well give 3M a competitive edge in the aftermath of the pandemic. Roman reminded investors that 3M's business model is "to build capabilities regionally around the world, close to customers and to build our business as the economies grow." 

This is an important point because the COVID-19 pandemic has caused many companies to consider the risk in their supply chains. As such, there's an interest in shifting production to new countries, or sourcing product from new regions. Such changes can naturally have a disruptive impact on the companies that supply manufacturers. As Roman noted, though, 3M already has regional capabilities in place in order to meet demand wherever its customers decide to move production.

The takeaway for investors

All told, it's not going to be easy to see the tangible improvements from the restructuring and transformational initiatives in the numbers until the distortive effects of the pandemic start to moderate. However, chief financial officer Nick Gangestad previously said he expected pricing to be positive for 3M in 2020, even in the face of falling volume. If so, this would demonstrate progress in management's efforts to improve the profitability of its businesses. So, look out for any further commentary on this subject. 

All told, the anecdotal evidence is positive and Roman is committed to taking action for shareholders. 3M looks like it's on the right path.Given the relative value in the stock and the potential for underlying improvement, 3M looks to be a decent option right now for income-seeking investors. 

Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends 3M. The Motley Fool has a disclosure policy.

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