Although the stock market is hovering around an all-time high, supply chain challenges, inflation, and a labor shortage continue to affect many companies. While some businesses have found a way to navigate these issues with ease, others are facing a flurry of short-term headwinds.
Investors may remember that the height of the COVID-19 pandemic sliced through the fundamentals of some of America's strongest companies, bringing many of them to their knees -- think companies like Starbucks, among many others. Just as those companies were great buys then, so too is the supply chain crisis paving the way for some excellent buys right now.
Some of our contributors identified 3M (MMM 0.16%), General Electric (GE +1.96%), and Taiwan Semiconductor Manufacturing (TSM +2.73%) as three companies whose long-term potential more than offsets their short-term challenges. Here's what makes each value stock a great buy now.
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Supply chain challenges won't last forever
Scott Levine (3M): Even if you paid casual attention to 3M's third-quarter 2021 conference call, you'd surely have gotten the impression that supply chain challenges plagued the company in the recently completed quarter. How extensive was the issue? Pretty extensive -- the phrase "supply chain" appeared 41 times on the call.
More importantly than the frequency of the phrase, though, was the effect of the supply chain disruptions on the company's financials. Though not disastrous, the effect was notable. Supply chain challenges -- compounded by the company's growth and sustainability investments, as well as legal costs -- led to a year-over-year 1.4% contraction in the operating margin. This, in turn, translated to a $0.02 negative impact on the 3M's quarterly earnings per share (EPS). And it wasn't only the income statement that bore the brunt of the impact of the supply chain challenges: The cash flow statement took a hit as well. The company reported that the issue factored significantly into generating a slimmer adjusted free cash flow conversion rate of 98% for the past three quarters, compared with a rate of 125% during the same period last year.
Take a step back, however, and you'll find that the company foresees growth in 2021 despite the headwinds. During the earnings presentation, 3M narrowed its EPS forecast to $9.70 to $9.90 from the original guidance of $9.70 to $10.10. Should the company achieve the midpoint of this range, it will represent nearly 6% growth over the $9.25 it reported in 2020.
While no one has a crystal ball and can be sure of when the supply chain challenges will abate, 3M's management believes that they will extend into 2022. Undesirable as this may be, 3M in a strong financial position. The company has a net debt-to-EBITDA ratio of 1.3, illustrating that it isn't overly reliant on leverage, and it has a solid balance sheet to help it weather the current challenges. With the stock trading at 13.3 times operating cash flow, a discount to its five-year average multiple of 16.5, investors can scoop up an industry stalwart at a bargain-bin price.
Investors should warm to GE's plans to split into three different companies
Lee Samaha (General Electric): It's fair to say GE blindsided investors by announcing an intent to split into three separate companies. But in a sense, it reminds investors that a business' long-term development is more important than a few quarters of supply chain cost pressures and revenue constraints.
Management will spin off the healthcare business in early 2023, retaining a 19.9% stake. Meanwhile, the power, renewable energy, and GE Digital businesses will be combined and spun off as one company in early 2024. The remaining GE will be an aviation-focused company.
GE's long-term plans make sense, not least because its fierce rival in healthcare, power, and renewable energy, Siemens, did a similar thing when it spun off Siemens Healthineers in 2018. It then combined its gas and power business with its stake in renewable-energy company Siemens Gamesa and then spun it off as Siemens Energy in 2020. Sound familiar?
The logic behind GE's decision is the same. There's little crossover between healthcare and the rest of GE's businesses, and a standalone healthcare business will probably command a premium to GE's current rating. Meanwhile, combining power and renewable energy makes sense, as they both serve the electricity generation market, and GE Digital is focused on those industries anyway.
Finally, aviation businesses are typically valued differently from other industrials to reflect their long-term potential. That's particularly relevant for a business like GE Aviation that generates long-term earnings and cash flow from services revenue for decades after selling an engine.
It all adds to a collection of businesses that could be valued higher when separate than they are when held together under GE. If so, the breakup news is good news.
This industry leader has growth and value written all over it
Daniel Foelber (Taiwan Semiconductor): The largest chip foundry in the world, Taiwan Semiconductor, is an excellent example of a company that has been hit hard by supply chain issues but has a bright long-term future. In its third-quarter conference call, Taiwan Semi said it expects its capacity to remain challenged throughout 2022 as it navigates supply chain challenges. Over the long term, it's spending a lot of money to grow capacity to meet the need for more chips. Specifically, it sees the most growth potential from 5G and high-performance computing, which complements its smartphone, internet of things, and automotive applications.
Despite the supply chain challenges, Taiwan Semi expects to finish 2021 with 24% year-over-year revenue growth. The company is nothing short of a cash cow and has done an impressive job retaining a strong operating margin despite higher costs.
TSM Revenue (Quarterly) data by YCharts
The semiconductor industry is becoming increasingly competitive, and Taiwan Semi has been adamant about the need for record-high spending so it can safeguard its industry-leading position in advanced computing and specialty technologies and can also meet the need for energy-efficient computing. Few companies could ramp up spending to the extent that Taiwan Semi is without severely affecting margins. The fact that Taiwan is doing that in a challenging business environment is all the more impressive.
With a price-to-earnings ratio of 30, strong growth, and a 1.6% dividend yield, Taiwan Semiconductor is a good all-around value in an industry with a lot of upside.
