Saturday, January 12, 2013

3M Stock Analysis


It's time for another stock analysis report and this time I'll look at another dividend champion, 3M (MMM).  3M closed trading on Friday, January 11th at $96.28.

Company Background:

3M Company operates as a diversified technology company worldwide. The company’s Industrial and Transportation segment offers tapes, coated and non-woven abrasives, adhesives, specialty materials, filtration products, energy control products, closure systems for personal hygiene products, acoustic systems products, and components and products used in the automotive, marine, aircraft, and specialty vehicles. Its Health Care segment provides medical and surgical supplies, skin health and infection prevention products, inhalation and transdermal drug delivery systems, dental and orthodontic products, health information systems, and food safety products. The company’s Consumer and Office segment provides office supply, stationery, construction and home improvement, home care, protective material, certain consumer retail personal safety, and consumer health care products. Its Safety, Security and Protection Services segment offers personal protection products, cleaning and protection products for commercial establishments, safety and security products, roofing granules for asphalt shingles, corrosion protection products used in the oil and gas pipeline markets, and track and trace solutions. The company’s Display and Graphics offers optical film solutions for LCD electronic displays; computer screen filters; reflective sheeting for transportation safety; commercial graphics sheeting and systems; architectural surface and lighting solutions; and mobile interactive solutions. Its Electro and Communications segment provides electronic and interconnect solutions, micro interconnect systems, high-performance fluids, high-temperature and display tapes, telecommunications products, electrical products, and touch screens and touch monitors. 3M Company also offers electronic toll collection and parking management hardware and software.

DCF Valuation:

Analysts expect 3M to grow earnings 9.73% per year for the next five years and I've assumed they can continue to grow at 3.50% per year thereafter, right around the long term inflation rate. Running these numbers through a two stage DCF analysis with a 10% discount rate yields a fair value price of $123.02. This means that at $96.28 the shares are undervalued by 21.7%.

Graham Number:

Over the last 12 months, 3M's EPS were $6.26 and it's current book value per share is $25.50. The Graham Number is calculated to be $59.93, which means it is currently overvalued by 60.6%.

Average High Dividend Yield:

3Ms average high dividend yield for the past 5 years is 3.45% and for the past 10 years is 2.90%. This gives target prices of $68.46 and $81.44 respectively based on the current annual dividend of $2.36.  These are overvalued by 40.6% and 18.2%, respectively.  I think the 10 year average high dividend yield is much closer to what you'll see in the future if not just a bit higher.  The 5 year average is skewed higher thanks to the near 5% yield offered in 2009.


 Average Low PE Ratio:

3M's average low PE ratio for the past 5 years is 11.80 and for the past 10 years is 14.34.   This corresponds to a price per share of $80.98 and $98.35 respectively based off the analyst estimate of $6.86 per share for fiscal year 2013.  The 5 year and 10 year low PE price targets are overvalued by 18.9% and undervalued by 2.1%, respectively.  Both of the average PE ratios are reasonable so we'll use the 5 year average to be conservative.

Average Low P/S Ratio:

3M's average low PS ratio for the past 5 years is 1.46 and for the past 10 years is 1.97. This corresponds to a price per share of $75.98 and $93.91 respectively based off the analyst estimate for revenue growth from FY 2012 to FY 2013.  Their current PS ratio is 2.26 over the last 12 months.  The 5 year and 10 year low PS price targets are overvalued by 75.98% and 93.91%.  We'll use the 5 year average low PS ratio since it's more recent and conservative.

Dividend Discount Model:

For the DDM, I assumed that 3M will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be the 5 year growth rate of 4.21%.  After that I assumed they can continue to raise dividends for in perpetuity at 3.50%.  The dividend growth rates are based off fiscal year payouts and don't necessarily correspond to quarter over quarter increases.  To calculate the value I used a discount rate of 10%. Based on this, 3M is worth only $36.65 meaning it's overvalued by 162.7%.

PE Ratios:

3M's trailing PE is 15.38 and it's forward PE is 14.03.  The PE3 based on the average earnings for the last 3 years is 16.13. I like to see the PE3 be less than 15 which 3M is currently over.  Compared to it's industry, MMM seems to be undervalued versus JNJ (23.70) and overvalued versus the industry as a whole (14.80).  All industry comparisons are on a TTM EPS basis.  3M's PEG for the next 5 years is currently at 1.55 while JNJ is at 2.31 and the industry is at 0.87.  A low PEG ratio is better because it means that you're paying less for the growth of the company.

Fundamentals:

3M's gross margin for FY 2010 and FY 2011 were 52.3% and 51.2% respectively. They have averaged a 53.2% gross profit margin since 2001 with a low of 51.2% in FY 2011. Their net income margin for the same years were 15.3% and 14.5%.  Since 2001 their net income margin has averaged 13.9% with a low of 8.9% in FY 2001.  I typically like to see gross margins greater than 60% and at least higher than 40% with net income margins being 10% and at least 7%.  3M falls short of the gross margin requirement but a 53% average over 10 years is still very respectable.  The average net income margin is well over the 10% threshhold, so it's a win here.  Of course each industry is different and allows for different margins, so let's see how 3M has done when compared to their industry.  For FY 2011, 3M captured only 130.9% of the gross margin for the industry and 115.1% of the net income margin.  They're able to turn much more of their revenue into profit which is always good to see.  Their cash-to-debt ratio for the same years were 0.79 and 0.49.  I prefer for company's I'm investing in to have very little debt on their books and to have a cash-to-debt ratio greater than 1.  This is the only real issue that I see with 3M, especially since they're moving backwards on this front.  I'll be interested to see how this turns out once they report their full year results for 2012.

Share Buyback:

3M's shares outstanding have had a decent run since 2001 with an average of 1.06% of the shares outstanding being retired each year.  However, there has been 3 years where they increased.  They've bought back over 10% of the shares outstanding since 2001.  By repurchasing shares, 3M is able to increase EPS and management can return cash to shareholders this way by increasing the ownership share of the company for all the outstanding shares.  However, if the shares are being bought at overvalued prices this is detrimental to the shareholders,


A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.

Dividend Analysis:

3M is a dividend champion with 54 consecutive years of dividend increases.  Their current annual dividend sits at $2.36 for a current yield of 2.45%. MMM's annual increase for the last 1, 3, 5 and 10 years have been 7.27%, 4.98%, 4.21% and 6.65%.  These numbers might be different from the actual quarterly increases since they are based off the dividends paid out during each fiscal year.  Their payout ratio has decreased over the years which is good too see.  In 2001 it sat at 67.0% and finished at 36.9% in 2011.  This is great news for investors since this gives the company more room to increase the dividend in the future without taxing the operations of the company.


Their FCF per share has been pretty good over the years.  Since FY 2001 they've only had 1 really poor year which was 2002.  I'd still like to see the FCF payout ratio come down however, since 2001 saw a 90% payout.  Cash flow is the lifeblood of a company, so hopefully management can make improvements here.


Return on Equity and Return on Capital Invested:

3M's ROE has averaged 28.9% since 2001 with a low of 22.3% and a high of 35.3%.  Their ROCI has averaged 22.9% since 2001 with a low of 17.8% and a high of 28.3%.  For both ROE and ROCI I don't necessarily look for any absolute values rather I like to see stable or increasing levels over the long term.  3M's ROE and ROCI have been relatively stable with a slight uptrend since 2001.


Revenue and Net Income:

Since the basis of dividend growth is revenue and net income growth, we'll now look at how 3M has done on that front.  Their revenue growth since 2002 has been fairly strong at 6.30% per year and their net income has been growing at an 11.59% rate.  Since their net income has been growing faster than revenue, their net income margin has increased from 8.89% to 14.46% between FY 2001 and FY 2011.  This means that management has been able to get operations more efficient and they are able to keep more pennies from every dollar of sales to reinvest in the company or return to shareholders.  Revenue has grown every year since FY 2001, except from FY 2008 to FY 2009 which is to be expected.


Forecast:



The chart shows the historical high and low prices since 2001 and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 5 years and 10 years whichever is least.  Since I think the 5 year average low PE of 8.76 is going to be more typical for MMM, I'll use that number.  I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. In this case the target low PE is 11.80 and the 0.75 * PE is 8.85.  This corresponds to a entry price of $55.95 based off the expected earnings for FY 2012 of $6.32.  Currently 3M is trading at a $35.55 premium to the 75% low PE target price.

Conclusion:

The average of all the valuation models gives a fair value $76.33 which means that 3M is currently trading at a 26.1% premium to the average fair value. I've also calculated the fair value with the highest and lowest valuation methods thrown out.   In this case, the DCF and DDM valuations are thrown out and the new average is $74.58.  3M is trading at a 29.1% premium to this price as well.

Assuming that 3M can grow their earnings and dividends at the rates that I assumed you're looking at decent returns for the next 5 years.  In 2018 EPS would be $9.95 and slapping an average PE of 13.07 gives a price of $129.99.  Over the next 5 years you'd also receive $13.38 in dividends for a total return of 48.91% which is good for a 8.29% annualized rate.  If you purchase at the fair value price of $76.33 your projected total return is 187.83% for an annualized return of 13.44%.  I think these are fairly conservative assumptions since 3M should be able to grow their dividend faster than the 4.21% annual increase.

Overall, I would say that 3M is overvalued right now.  They could be set for elevated growth if the economy returns to normal levels since they supply just about every office product that there is.  They are a huge conglomerate that doesn't really suffer many down years thanks to the breadth of the product offerings.  I'd like to own some 3M in the future, but the value just isn't there at current prices.  The 2.75% yield level is at $85.82 and the 3.00% yield is at $78.67.  3M is due for an increase in their dividend on their next payment.

What do you think about 3M as a DG investment at today's prices?

15 comments:

  1. That was a very nice analysis of 3M. I've always liked that company, but it's always seemed a bit overvalued to me, with too low of an entry yield slow growing dividends. But that growth might be accelerating as the economy improves. I might buy some on a dip one day.

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  2. I really like 3M especially since they have their hands in so many different things that they don't really have many down years. I missed my chance to get in at a reasonable price back in late 2011, so for now we play the waiting game. I'll be curious to see what the next dividend increase gives, it was a little disappointing to see that the rates were that low, although the last increase was higher so it could be on an upswing. Should be interesting to watch.

    Thanks for stopping by!

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  3. Nice analysis. I remember looking at MMM back in mid-2012, when it was trading in the mid-80s. I figured that a good entry point would be in the mid-70s, which is consistent with your analysis. I like the business and its operating results, so it would be a nice addition to my portfolio. However, despite the long dividend growth streak, I am a bit turned off by the low dividend growth rate. The most recent increase of 7% was fine, but looking back over several years, they often have increases below 5%. I generally seek out companies with consistent dividend growth rates of at least 7%.

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    Replies
    1. DGM,

      I wish I had jumped on it in the $70's but that's passed. Like you I've been disappointed with the recent dividend growth. Sure would like to see that jump higher. The payout ratio has been coming down so we could see a pick up in the growth rate.

      Congrats again on the new job and thanks for stopping by!

      Delete
  4. PIP, do you have DDM in spreadsheet willing to share? I am lazy to create my own and tried to search on the internet a finished spreadsheet. If I don't find it, fine I can make my own, but trying to ask before creating my own.

    Great analysis of 3M.

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    Replies
    1. Martin,

      I do have one but its not all that pretty. Its not on Google spreadsheets right now and I'll be really busy with work tomorrow and then driving home. If you give me a few days I'll see what I can do about getting a much more user friendly one built up and uploaded to Google spreadsheets.

      Delete
  5. Pursuit,

    Great analysis here. 3M is one of those high quality companies that I'd love to have in the fold, but I just have not been able to make it work. Either the valuation was too high, which made the yield too low...or the growth rate just wasn't there. Certainly one of those solid blue chip companies that I gravitate towards, but the numbers just haven't worked out for me. Perhaps in the future!

    Best wishes.

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    Replies
    1. DM,

      Agreed. I was surprised to see the DG as low as it is. Although since the payout ratio has come down even during the mess of an economy these last few years it could provide some nice room for elevated growth going forward. But the valuation isn't there right now. I'd need a pullback at least to the mid-$80's to think about starting a position but that'd only come if they announced plans for higher DG going forward or show it with a pretty significant increase which they should be announcing before their next payout.

      I really like the size and breadth of their products. They have their hand in just about every facet of the economy, plus their office products are used by almost every single company out there. So 3M would definitely qualify as safe to me.

      Thanks for stopping by!

      Delete
  6. Great analysis! I love MMM as well but have never been able to have it come down in buying range.

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    Replies
    1. Marvin,

      Yeah the last opportunity to get in at a good price was back in September 2011, since then there's not really been any good chances. Although the DG has been a little subpar the last few years, hopefully that picks back up and we can get some good entry prices.

      Thanks for stopping by!

      Delete
  7. Thanks for this analysis! I'm also a big fan of 3M and have been patiently waiting for a good time to load up on some. One of my uncle's worked for 3M for many years and purchased a boatload of 3M stock during the early 80's and 90's. He kept on re-investing the dividends, and the next thing I know, he's basically a millionaire. He probably doesn't even know what a dividend aristocrat, or P/E ratio, but he was smart enough to just keep buying 3M. Some good luck, huh?

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    Replies
    1. Wow, talk about great timing on that. It's a good thing he was getting either payment or ESPP shares and reinvesting them. $1,000 invested 1985 is now worth $23,000. And that's just for 1 year and doesn't even show the dividends that it's currently spinning off. I can't remember who, but one of the authors on SA worked for KO. I'm really jealous of him. He's got a boatload of shares that just keep churning off more and more dividends ever year.

      Thanks for stopping by!

      Delete
  8. 3m is an excellent company. They are also very diverse in their product line it ranges from consumer products to industrial. They also have divisions in the healthcare area.

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    Replies
    1. 3M is a great company, unfortunately I missed the really good value when it was in the $70's. The number of products they have is just amazing. Name an industry and they've got something for it, even if it's just office products.

      Thanks for stopping by!

      Delete
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    ReplyDelete