Investing in these two industrial giants makes for a fascinating comparison. Back in 2019, 3M's (MMM -0.70%) market capitalization was higher than Honeywell's (HON -0.87%). Yet, fast forward to now and Honeywell's is almost double 3M's.
Still, investing is all about where a company is going, not where it's been. 3M's valuation discount and 4.7% dividend yield make it an attractive proposition for income-seeking investors, but is it enough to make it more attractive than the higher-quality but premium-priced Honeywell?
Let's take a look based on three key factors: pricing power, growth potential, and stock valuation.
1. Pricing power and margin expansion
The best way to gauge a company's pricing power is to look at the evolution of its gross profit margin. This is the profit left after taking out the cost of goods sold, so it excludes selling, general, and administrative costs. If a company can raise prices over and above its costs without losing sales volume, it can increase its gross profit margin.
The following chart shows how 3M's gross profit margin declined while Honeywell's increased. While they are different businesses, it's the trend that matters.
Data by YCharts
The subject of pricing came up in 3M's latest earnings update. On the conference call, CFO Monish Patolawal said that 3M's price increases would "offset" an estimated $750 million to $850 million in raw materials and logistics inflation in 2022.
In fact, 3M has been trying to offset cost increases for a while. However, the company's third-quarter performance doesn't give much optimism -- gross profit margin declined again to 45.1% from 45.7% in the same quarter of last year.
In comparison, Honeywell increased pricing by a whopping 11% in the third quarter, and its gross profit margin expanded to 33.1% compared to 32.2% in the same quarter of last year. Key takeaway: Honeywell has demonstrated pricing power in its product portfolio, enabling the margin expansion that 3M hasn't shown in recent years.
2. Growth aspirations
Wall Street analysts expect Honeywell to grow revenue at a 4.6% annual rate to 2024, compared to no growth for 3M over the same period. The estimate for Honeywell is at the low end of management's long-term target of 4% to 7% and reflects a host of growth businesses -- from sustainable technology (green aviation fuels, recycled plastic, batteries) to quantum computing, propulsion, and avionics for use in air taxis and drones.
By contrast, 3M's growth has struggled in recent years, and management only expects organic sales growth of 1.5% to 2% for 2022 compared to Honeywell management's estimate of 6% to 7%.
Key takeaway: Honeywell has a host of growth businesses, while 3M is struggling to escape the orbit of GDP-type growth.
3. Valuation matters
Finally, in terms of valuation, there's only one winner here. Whichever way you cut it, 3M is cheaper and -- at least superficially -- looks like a good value while Honeywell seems expensive.
Data by YCharts
Key takeaway: 3M trades at an eye-catching discount to the expensive-looking Honeywell.
Which stock is better?
This leads to the inevitable question of which stock is better overall. The answer is Honeywell.
3M's valuation discount partly reflects the company's significant legal risk over ear plugs made by one of its subsidiaries. But it also reflects some disappointing operational performance over the last decade. The legal risk is certainly a factor in 3M's discounted valuation, but it's very hard to put a figure on exactly what that risk is -- so trying to guess whether 3M is undervalued based on it is extremely difficult.
In the end, and putting the legal risk aside for the moment, 3M is still a business that's struggling to grow and seems to be suffering margin erosion. Meanwhile, Honeywell's best days appear to be ahead of it. Given the choice of the two, Honeywell looks the better option.
