Wall Street analysts typically go into hiding every three months when the long-awaited earnings season kicks off, making them earn their paychecks through long hours of due diligence and financial modeling. This time, you bet they had to dig into 3M Company (NYSE: MMM) and its unusually high potential.
With financial titans like BlackRock Inc. (NYSE: BLK) and Goldman Sachs (NYSE: GS) advising their clients — and also their own funds — to move into undervalued stocks and seek quality yield in dividend stocks or fixed income, 3M may look like one of the easiest wins for your portfolio in the next 12 months.
Regarding conglomerate stocks, namely those in chemicals and basic materials, you can use MarketBeat's fantastic stock screener to find out just how undervalued 3M stock is today. Part of those low price-to-earnings ratio and high dividend yield names, it will be no surprise to you when it outperforms the market.
Value gap
Looking over this sector, you can find a few critical trends to help you make an educated decision for this value play. An average forward P/E ratio of 12x is the benchmark valuation for stocks like Honeywell International (NASDAQ: HON) and Dow Chemicals (NYSE: DOW), considered competitors for 3M.
While 3M trades today at 25% below the industry, its competitors begin looking quite expensive. Honeywell trades for 17.6x and Dow for 12.6x, making 3M the apparent outlier in this group.
The market is suppressing 3M's price into these undervalued levels amid news surrounding lawsuits and other negative media.
Remember, news always follows the stock price, so investors like yourself should use their heads to break down the real value to be unlocked here.
Analysts only see a 17% upside in the stock from today's prices. In comparison, Honeywell and Dow see 22% and 19%, respectively.
3M offers a 6.8% yield today, which beats inflation, and the 10-year bonds offer nearly 5%.
Tailwinds abound
Markets don't like uncertainty, and pending lawsuits are as big an uncertain event as they come, so settling only brought definite certainty for the future of 3M. With a "forever chemicals" water supply lawsuit settled and now a military earplug, 3M is out of the crosshairs.
Now, some bears argue that the settlement payments would bring an added risk to the company's cash flow and, in sequence, put its high dividend yield at risk of being canceled or lowered. However, the numbers don't lie and will bring some sense into this argument.
With a payment schedule set as far as 2029 to complete the totality of the settlement amounts, which can be as high as $15 billion in the worst case, would require that 3M pay at most an annual sum of $2.5 billion a year.
Looking at 3M's financials, you can figure that over the past five years, the company has generated an average free cash flow level of $5.3 billion, so that annual lawsuit payment — while significant — is not a direct threat to buybacks or dividends.
With the latest quarterly results, you can better understand how the company is set up for success during those "tighter" free cash flow conditions to put fears to rest.
The company's management boasted about their cost-cutting initiatives saving the business millions this quarter, allowing higher margins and increased free cash flow expectations for the rest of the year and upcoming 2024.
Management directly commented that operating cash flows will be in the range of $6.5 to $6.9 billion, up from previous guidance of $5.9 to $6.3 billion. This comes after the stock beat analyst EPS expectations by over 14.5% to end a profitable quarter on $2.68 EPS.
Not only was the dividend kept during these uncertain times, but management also cast a vote of confidence by buying back as many as 15.7 million shares for an estimated $31 million.
