Here’s Why 3M Stock Looks Undervalued At $175

MMM: 3M Company logo
3M Company

The stock price of 3M Company (NYSE:MMM) is up 52% from the levels it was on March 23, 2020, when broader markets made a bottom due to the spread of Covid-19. This marks an underperformance compared to the S&P which has moved 70% since its March 2020 lows, with the resumption of economic activities as lockdowns are gradually lifted and vaccination programs have been initiated in multiple countries. This underperformance can partly be be attributed to investor concerns over lawsuits surrounding the environmental issues related to manufacturing plants, as well as for product safety (earplugs). MMM stock is also down 25% from levels of around $235 seen in early 2018.

Most of the 25% decline of the last 3 years can be attributed to a contraction of the company’s P/E multiple. Looking at the company’s fundamentals, its total revenue has hovered around the $32 billion mark between 2018 and 2020, as growth in the Healthcare segment offset lower sales for Safety & Industrial and Transportation & Electronic segments. 3M’s net margins also have remained stable at 16.7% in 2020, compared to 16.3% in 2018. This clubbed with a 2% decline in total shares outstanding due to share buybacks, meant that the company’s earnings grew 2.5% to $9.32 in 2020, compared to $9.09 in 2018, on a per share and GAAP basis. Despite the steady performance over the recent years, MMM stock has declined, and we believe it is likely to see an upside in the near term. Our dashboard, ‘What Factors Drove -25% Change In 3M’s Stock between 2017 and now?‘, has the underlying numbers.

3M’s P/E multiple contracted from 24x in 2018 to 18x in 2020. While the company’s P/E is 19x now (based on trailing EPS), there is a potential upside given the expected growth in EPS over the coming years, as well as comparing the P/E multiple to levels of 24x seen in 2018.

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So what’s the likely trigger and timing for upside?

Despite the challenging current environment given the pandemic, 3M did not see any decline in total revenue in 2020, courtesy of its Healthcare segment and increased demand for N95 masks and PPE (personal protective equipment). As we look into Q4 2020, 3M has seen a 6% revenue growth, led by continued demand for safety products. In fact, Safety & Industrial revenues were up 13% during the quarter. The company has also managed to grow its net margins by a strong 430 bps to 16.9% in Q4 2020, led by lower SG&A and R&D expenses. A steady revenue growth clubbed with margin expansion has meant that 3M’s EPS grew 43% over the same period.

Looking forward, there are multiple factors that will likely result in stock price growth over the coming years.

1. The company’s Healthcare segment has seen benefits from Acelity and M*Modal acquisitions that were completed in 2019. Acelity specializes in advance wound care while M*Modal makes cloud-based AI powered systems for patient narratives. These acquisitions will aid the overall revenue growth as well as margins expansion going forward, boding well for its stock.

2. The company is also exploring the possibility of spinning off its food safety business, which could garner as much as $3.5 billion, unlocking value for shareholders.

3. While Covid-19 has led to improved demand for safety products as well as home care and home improvement products, the office products sales along with automotive aftermarket have seen a decline. Now, as the Covid-19 crisis abates, this trend is likely to reverse with demand for healthcare and safety materials to likely slow, while the demand for automotive aftermarket, electronics, and other industrial products will likely trend higher. This is important given the Healthcare and Personal Safety businesses account for 37% of total sales, while Consumer, Industrial, Transportation and Electronics make up for the rest.

Finally, looking at valuation, at the current price of $175, 3M is trading at 18x its estimated adjusted EPS of around $9.60 in 2021, compared to levels of 26x seen in 2017, and 20x seen in 2019 and 2020, implying there is more room for growth for MMM stock. Even when compared to some of the other industrial companies, including Honeywell and Johnson Controls, 3M is trading at a lower multiple. The 18x figure for 3M based on 2021 EPS, compares with a 26x figure for Honeywell and 22x for Johnson Controls.

While MMM stock may see higher levels, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Honeywell vs. Roper Industries.

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