Better Buy: 3M or Stanley Black & Decker?

Both Stanley Black & Decker (SWK -0.01%) and 3M (MMM 0.57%) are Dividend Kings that have experienced a torrid 2022, with the former down 57% and the latter down 36%. That said, investors buy stocks based on looking forward rather than looking back.

If you're a value-orientated investor looking for a stock to buy on a dip while waiting for a recovery (and enjoying a good dividend), then buying one or both of these stocks might make sense. Here's the lowdown. 

Stanley Black & Decker in 2022

Stanley Black & Decker's management started the year expecting a gradual easing of supply chain pressures and raw-material costs. This would lead to profit-margin expansion and ongoing strength in sales of do-it-yourself tools and outdoor products. Unfortunately, the supply chain pressures have proved unrelenting.For example,management started the year expecting $800 million in cost inflation, only to upgrade that figure to $1.4 billion in late April.

This was aggravated by lockdowns in China, the conflict in Ukraine, and a combination of slowing consumer spending and unfavorable weather. Throw in the negative impact on the housing market of rising interest rates, and Stanley could face more pressure in the near future.

In response, management has launched a significant restructuring of its supply chain and operational structure to cut costs by a whopping $2 billion in three years. So the investment case for the stock is based on a combination of the restructuring plan working and the company muddling through a challenging trading environment. 

3M in 2022

The situation at 3M is more nuanced. It's based on the company disappointing investors by cutting full-year guidance on the back of raw material and logistics cost headwinds. The company cut its full-year earnings guidance from a range of adjusted earnings per share (EPS) of $10.75-$11.25 to $10.30-$10.80. This is relatively slight, compared to Stanley's cut from a range of adjusted EPS of $12-$12.50 to $5-$6. Moreover, it's fair to say that 3M is definitely not the only industrial company to suffer from more-significant-than-expected supply chain issues and raw material cost inflation this year.

A large part of the reason for 3M's fall from grace comes from concerns over its well-documented legal issues, not least from faulty combat earplugs and the manufacture of PFAS chemicals. The market is worried about 3M's liability. To demonstrate this, here's a look at price to free cash flow (FCF) estimates (based on Wall Street analyst consensus) of 3M, compared to a peer, Illinois Tool Works.

For argument's sake, let's assume 3M's valuation "should" be around equivalent to that of ITW's 2023 price to FCF multiple of 19.5 times FCF. Plugging in Wall Street estimates for 3M's FCF of $5.9 billion in 2023 (using the 19.5 times multiple) gives a potential valuation for 3M of $115 billion. That difference between $115 billion and 3M's current market cap of $62.2 billion is $52.9 billion, which seems a considerable number to factor in for potential liabilities. Still, Wall Street analysts have some pretty dramatic "worst case" scenarios pencilled in. For example, Wall Street analyst Steve Tusa of JPMorgan is on record as giving an estimate of anything from $2 billion to $185 billion for potential liabilities. 

Data source: Marketscreener.com, author's analysis.

3M or Stanley Black & Decker?

Both companies are far from perfect, but I think Stanley Black & Decker is the better option. The critical difference is that much of its upside potential is in management's own hands. It's tough for 3M's management to predict precisely the outcome of its legal difficulties.

Stanley trades on less than 12 times analyst estimates for 2023. With more cost savings -- $1 billion in 2023 and another $1 billion within a couple of years after that -- there's potential for substantial appreciation.