We think that 3M (NYSE: MMM) currently is a better pick compared to Medtronic (NYSE: MDT). 3M trades at about 3.1x trailing Revenues, compared to over 5.4x for Medtronic, though both belong to different industry groups. But does this gap in 3M’s valuation make sense? While 3M has also taken a hit in the current pandemic, the impact on its sales have been much lower than that for Medtronic, as we discuss in the sections 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 Medtronic, which over the years has seen increased demand for its medical devices and related products. 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 3M vs. Medtronic: Is MMM Stock Appropriately Valued Given Its Significantly Lower P/S Multiple Compared to MDT? has more details on this. Parts of the analysis are summarized below.
1. Revenue Growth
Between fiscal 2017 and 2020 (fiscal ends in April), Medtronic’s Revenues declined 2.7%, from $29.7 billion to $28.9 billion. Note that fiscal 2020 revenues were actually down over 5% as it included a quarter of lockdowns amid the pandemic. 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 had divested its Communications business in 2018, and its Drug Delivery business this year. Looking at the last few years, 3M’s revenue growth trended better compared to Medtronic.
2. Returns (Profits)
While Medtronic’s Free cash flows as a % of Revenues stood at about 25% in 2019, rising from around 23% 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 higher compared to Medtronic’s in 2019, standing at about 19% versus about 8%. Medtronic’s Total Shareholder Returns (TSR) have been higher, driven by over a 40% jump in the stock price since the end of 2017 and growing dividends. While 3M has also raised its dividend over the recent years, its stock has actually declined by over 25%.
Medtronic’s Debt load is slightly higher at around $25 billion (fiscal 2020), with its Debt to Equity ratio standing at about 16%, declining from levels of 23% in 2016, due to a reduction in debt. 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
Interestingly, 3M’s Revenue Growth and Risk metrics compare favorably, while the Returns metrics are also comparable with Medtronic’s, and as such, we don’t think this really justifies the company’s low P/S multiple of 3.1x versus 5.4x for Medtronic. We also acknowledge that historically there has been a valuation gap between these two companies given the different sectors, but now that 3M is also seeing Healthcare segment as a big opportunity, we believe this valuation gap could narrow. Also, comparing 3M’s current P/S of 3.1x vs. 4.1x seen in 2017 tells us that there is a room for growth, while Medtronic’s current P/S of 5.4x is actually at the highest level it has been over the recent years, and compares with 4.1x figure seen in 2017, again implying the valuation gap could narrow.
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 a strong rebound in sales. Secondly, the company is also exploring the possibility of spinning off its food safety business, which could fetch $3.5 billion, unlocking value for shareholders. Medtronic, on the other hand, is also expected to see a strong pickup in demand post the pandemic as the volume of procedures is expected to rise over the coming months. That said, we believe the valuation gap between these two companies will likely narrow, and 3M could offer better upside compared to Medtronic.
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