As investors, we tend to concentrate on two types of situations: gung-ho growth or cheap value. Anything in between is a yawn, for the most part.
Yet in my investing career, the many roads to regret aren't punctuated by billboards featuring the charts of runaway trains a year ago, or even value successes like Nokia last summer. The signs I missed were big but boring powerhouses. Companies that weren't growing quickly, and weren't trading for deep discounts, but just continued to do their thing, leaving many of my stocks in the dust over the past couple of years. I'm talking about companies as diverse as Altria
Well, not today. Today I'm paying attention. Today I'm talking about 3M
OK, this Minnesota boy's been waiting a while to work that into an article. (Just don't ask me about the mosquitoes, which are so big they have wood ticks.) But I think it's fair -- if a bit frat-boyish -- to pump a fist and say that 3M rules. At least it has treated long-term shareholders pretty well. Why? One reason is that it is one of those diversified manufacturers that's a part of what we do every day here in America, and increasingly, around the world (where 60% of revenues now originate). From health-care products to industrial materials, we couldn't avoid 3M if we tried.
In a quick check of my own surroundings, I find that I have 3M masking tape, sandpaper, reflective tape, medical tape, sticky notes, sticky hooks, glue sticks, transparent tape, carpet and fabric protectant, water repellent, spray adhesive, scouring pads, dust masks, Thinsulate in a variety of winter clothes, and probably a bunch of other stuff that I'm forgetting.
That may sound boring, but that's exactly the point. I think any company that can sell me 15 to 20 products without my even realizing it is worth a close look, especially when the analysts start treating it the way a baby treats a diaper. And the Street has been a bit unkind lately. As my colleagues W.D. Crotty and Stephen Simpson recently noted, when you're 3M, nothing seems to be good enough to impress the Street.
When sales increased a meager 4% in the first quarter, but cost savings caused operating profits to outrun that gain, and earnings per share (EPS) notched an even bigger pop because of share buybacks, the stock was pummeled anyway. No good deed goes unpunished, I guess.
Growth takes a vacation?
This seems to be the Street's major worry. Truth be told, 3M will likely see some slimming of the top-line growth rate, which stood near 10% in 2003 and 2004. I won't bother too much with going over the recent performance of 3M's several operating divisions. Let's just say the depth is both a blessing and a curse. It's nice to sell, say, a lot of sandpaper and bandages for those times when companies just aren't buying as many displays, but the reverse is also true. The laggards can take the shine off major gains in the hot divisions.
But keep in mind, per-share profit growth from 2002 to 2004 consistently outran sales growth, coming in at 20-plus percent. And despite the sleepy sales growth, 3M looks like it will stay on track for the shareholder's bottom line. Part of the reason is that 3M has continued to deploy its excess cash flow to buy back shares. And core profitability is also likely to improve. The firm remains in the midst of restructuring initiatives, focusing on re-engaging with its U.S. customers and reducing costs. It says that the efforts added $400 million to operating income for 2004, and it expects a similar benefit this year.
And I tend to believe management, mostly because the company has a long history of producing very good returns for investors. Five-year averages for returns on equity, return on assets, and return on capital are 29%, 13%, and 24%, respectively -- significantly higher than industry averages and way ahead of the S&P 500's benchmarks.
There are a few flies in the ointment at 3M. One of these is the impending (or not, depending on who calls in what favors when Congressman Cox puts his feet up on his desk at the SEC) fallout from expensing of stock-based compensation. The footnotes of the 2004 10-K show that pro forma earnings numbers adjusting earnings for stock-based compensation knocked the per-share tally back by about 5%.
Possibly the biggest risk to continued shareholder enrichment at 3M is -- as at many other major corporations -- the upcoming waves of retirees. Pension and post-retirement benefit plans were underfunded to the tune of $1.7 billion at the end of 2004. Moreover, sticklers for conservative accounting -- and real market bears -- will likely be spooked by the firm's assumptions of 8.75% returns on plan assets going forward. It has outpaced that in recent years with up markets, but should the worm turn, things could go from code yellow to code red in a jiffy, making it necessary to divert larger amounts of what would otherwise be shareholders' cash into pockets of retirees.
The price tag
My own simplified discounted cash flow (DCF) calculation for 3M -- assuming 10-5-3 earnings growth and a 10.5% discount rate -- pegs the value of a share somewhere around $84. Coincidentally, the S&P recently came up with a similar number -- using different inputs and a smarter group of analysts, I'm betting. So, by usual value standards, 3M looks only slightly undervalued, if at all. Let's call it a 90-cent dollar.
But I'm going to do something a bit heretical, which, I hope, won't get me thrown off the Motley Fool Inside Value bowling team. I'm going to suggest you consider paying that price anyway. Why? Because if we judge 3M to be fairly valued now, we would also have to admit that the market is used to paying a premium for the firm.
|Current||2004 Average||2003 Average||2002 Average||7-Year Average|
As the table shows, valued relative to its earnings, sales, or earnings before interest, taxes, depreciation, and amortization (EBITDA), 3M is rarely this cheap. And pay close attention to the last row. At a time when the company's shares have gone on sale -- albeit a modest sale -- it's producing higher net margins than it has seen in years. Allow me to channel my inner stock caveman for a moment.
"Stock get cheaper. Profit better. Cash flow good. Buys back shares and pays dividends." Do we need to get any more complicated than that?
The Foolish bottom line
If I asked you to make a list of companies that you were sure would be around for the next 30 years, I'm betting 3M would be on it. There are few businesses that inspire such confidence in their longevity, and fewer still that have actually earned that trust by putting up consistent returns for shareholders. Though it's not the kind of screaming deal we look for every month at Inside Value, 3M currently trades at a discount it doesn't usually offer. The truly cheap may just shuffle it onto the watch list, but investors in search of a core long-term holding could do a lot worse than buy 3M at today's prices, when Wall Street's worrywarts are looking past the obvious.
If you'd like a peek at strong companies selling for even deeper values, try 30 days of Inside Value for free. Join our team of value hounds, and you'll get two stock recommendations a month, as well as access to all 22 of our picks to date. Click hereto learn more.
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