3M Stock Looks More Attractive Than Honeywell

by Trefis Team
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3M Company (NYSE: MMM), a large conglomerate operating in industrial, worker safety, US health care, and consumer goods space, trades at about 3x trailing Revenues, compared to 4x for Honeywell International (NYSE: HON), another conglomerate which operates in the fields of aerospace, building technologies, performance materials and technologies. Does this make sense given that Honeywell has a significant exposure to the Aerospace segment, which has taken a hit in the current pandemic? While 3M’s business has also taken a hit in the current pandemic, the impact on its sales have been much lower than that for Honeywell, as we discuss in the section below. 3M is being weighed down by lawsuits surrounding the environmental issues related to manufacturing plants, as well as for product safety (earplugs). This has resulted in an underperformance of 3M stock vis-a-vis broader markets. While MMM stock is down over 25% since the beginning of 2018, over two years ago, the S&P 500 has moved higher by over 30%. HON stock, though, moved in-line with the broader markets. However, there is more to the comparison. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical Revenue Growth, Returns (ability to generate profits from growth), and Risk (sustainability of profits). Our dashboard Honeywell vs. 3M Company: Is HON Stock Appropriately Valued Given Its higher P/S Multiple Compared to MMM? has more details on this. Parts of the analysis are summarized below.

1. Revenue Growth

Between 2016 and 2019, Honeywell’s Revenues declined by about 7%, from around $39.3 billion to $36.7 billion. The decline can largely be attributed to divestiture of its turbochargers and home products businesses, excluding which the sales would have been up 21%. On the other hand, 3M’s Revenues grew by about 6% between 2016 to 2019, rising from around $30.1 billion to $32.1 billion, driven by strong growth in Healthcare and Consumer business, while 3M also divested its Communications business in 2018, and its Drug Delivery business this year. On a GAAP basis, 2.2% revenue growth for 3M over 3-year period compares with -2.0% for Honeywell.

2. Returns (Profits)

While Honeywell’s Free cash flows as a % of Revenues stood at about 19% in 2019,  rising from around 14% in 2016, 3M’s Free cash flows as a % of Revenues stood at about 22%, at the same level seen in 2016. While the Return on Invested Capital metric for both companies has been volatile, 3M’s ROIC was slightly lower compared to Honeywell’s in 2019, standing at about 19% versus about 25%. Honeywell’s Total Shareholder Returns (TSR) have been higher, driven by a surging stock price and growing dividends. While 3M has also raised its dividend between 2016 and 2019, its stock has underperformed.

3. Risk

Honeywell’s Debt load is slightly higher at $22.2 billion currently, and its Debt to Equity ratio standing at about 15% as of 2019. 3M’s Debt to Equity ratio has increased from 11% to about 17% over the same period, given an increase in total debt. Overall, neither company appears to have very meaningful financial risk.

The Net Of It All

Although Honeywell’s adjusted Revenue Growth, Returns, and Risk metrics compare a tad favorably with 3M’s, we don’t think this really justifies the company’s high P/S multiple of 4x versus 3x for 3M. Honeywell’s valuation is being driven by investor interest in its more profitable aerospace business over the recent years. On the other hand, 3M’s valuation is likely weighed down by lawsuits over its manufacturing plants and product safety. However, these issues could be transitory in nature and we do see a couple of factors that could help 3M stock in the near-to-medium term. Firstly, the company’s Healthcare segment has seen strong demand over the recent past, even during the pandemic with Q3 sales jumping 32% (excluding Drug Delivery). As economies open up, its other segments will likely see strong rebound in sales. Secondly, the company is also exploring the possibility of spinning off its food safety business, which could fetch it $3.5 billion, unlocking value for shareholders. Honeywell, on the other hand, could take a longer time to see a rebound in aerospace demand, given the significant hit on the overall industry during the pandemic. Its Aerospace segment sales were down 25% in Q3.

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio to beat the market, with over 100% return since 2016, versus about 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk, it has outperformed the broader market year after year, consistently.

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