With the markets rising strongly since April 2020, it's tempting to think that an economic recovery has already been priced into stocks. Following this argument means there's downside risk for stocks given any disappointment on the economy. That may well be the case for much of the market, but not all companies were created equal. In the case of 3M (MMM -2.43%), the shares still look like a good value and there's potential for improvement in sales and earnings in 2021. Here's why.
How 3M grew in the fourth quarter
3M's sales growth is being helped by COVID-19-related demand for respirator masks (safety and industrial segment) and respirators (healthcare segment), but other, more economically aligned businesses in those segments are yet to recover.
Image source: Getty Images.
In addition, the consumer segment is also receiving the benefit of stay-at-home measures boosting demand for home care and home improvement products, but stationery and office product sales remain weak.
Finally, the transportation and electronics segment returned to growth in the fourth quarter, but there's a lot of uncertainty around prospects for the automotive and electronics industries in 2021. That's something reflected in the wide guidance range given for 2021 shown in the table below.
|
Organic Sales Growth |
Q4 2019 |
Q1 2020 |
Q2 2020 |
Q3 2020 |
Q4 2020 |
Full-Year 2021 Outlook |
|---|---|---|---|---|---|---|
|
Safety & industrial |
(2.8%) |
2.2% |
(6.1%) |
6.9% |
11.4% |
Mid-single digits |
|
Transportation & electronics |
(5.9%) |
(3%) |
(18.9%) |
(7.1%) |
1.4% |
Low to high-single digits |
|
Health care |
(0.2%) |
1.2% |
(12.4%) |
8.1% |
6.6% |
Low to mid-single digits |
|
Consumer |
0.2% |
6.1% |
(5%) |
5.5% |
9.9% |
Low to mid-single digits |
|
Total |
(2.6%) |
0.3% |
(13.1%) |
0.9% |
5.5% |
3%-6% |
Data source: 3M presentations.
3M's game plan
It's clear that 3M's aim over the next couple of years is to finesse a transition from COVID-19-related revenue to more economically aligned revenue. As the pandemic subsides, mask, respirator, and home improvement sales growth should slow, but 3M should see an improvement in its more cyclically aligned sales. This includes 3M's industrial abrasives, electrical materials, automotive aftermarket, advanced materials, and non-COVID-19-related healthcare products.
There's plenty of potential to do so because 3M's cyclically aligned sales haven't fully recovered. In other words, there should be room to grow as automotive production improves, manufacturing plants open up, cars get driven, and non-COVID-related procedures take place. The following table helps to outline matters.
|
3M Segment |
Adjusted Earnings Before Interest, Tax, Depreciation, and Amortization in 2020 |
Notes on Fourth Quarter |
Management Commentary During the Earnings Call |
|---|---|---|---|
|
Safety & industrial |
$3.62 billion |
Organic growth of 11.4% in the fourth quarter, with respirator demand contributing nearly 90% of it |
"Channel partners continue to remain cautious given ongoing macroeconomic uncertainty" |
|
Transportation & electronics |
$2.36 billion |
Segment return to growth, but it came up against easier comparison from last year and will do so through 2021 |
The wide range in the guidance "contemplates the potential for end-market variability, particularly in automotive and electronics. " |
|
Health care |
$2.45 billion |
Taking out respirator demand, organic growth was flat. |
"The things that we are watching are, where does hospitalization go? What happens to elective procedures, both in the hospital and the oral care space?" |
|
Consumer |
$1.39 billion |
Home improvement and home care sales increased double digits |
"Does that strength continue in retail? When do schools reopen?" |
Data source: 3M presentations. Author's analysis.
How to think about 3M in 2021
The investment case for the company is based on three ideas.
First, 3M is a winner if the pandemic continues as mask, respirator, and stay-at-home-related sales will remain strong. In addition, it has the potential to do well if the economy opens up due to a subsiding in the pandemic. The last point is highlighted by the fact that there's still a lot of uncertainty baked into management's guidance -- see the last column in the table above.
Second, 3M's management has been actively restructuring for growth, and these internal initiatives are expected to improve performance in the future.
The COVID-19 vaccine should lead to an opening in the economy, which is good news for 3M's industrial sales. Image source: Getty Images.
Third, the downside on the stock is limited due to its attractive valuation. With adjusted free cash flow (FCF) of $6.7 billion in 2020, the stock trades on just 15 times its current FCF. Put another way, the company is generating 6.7% of its market cap in FCF. Theoretically, it could pay a 6.7% dividend yield from its yearly FCF and still be able to grow the business.
Is 3M a buy?
All told, the stock trades on a favorable valuation, it sports a 3.3% dividend yield, and its industrial-related sales have the potential to grow given an improvement in the economy.
As such, it's fair to say that 3M isn't one of those stocks that's highly valued on the hopes of an economic recovery in 2021. Therefore, it still represents an attractive and excellent value opportunity for investors.
