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Investors Please Take Note, Even in a Post-It!
Posted by: Victor Selva (IP Logged)
Date: October 8, 2013 04:28PM

A weak economic environment in developed economies added to a moderate growth in China and India are crucial for the Industrial Conglomerates sub-industry. However, the global economy is showing signs of improvement and this should help those companies. So let's take a look at two companies in this sector and see which one is doing better and will become the better investment.

3M Company (MMM) is a global company that operates as a diversified technology company with manufacturing operations around 70 countries. It was admirable how the company survived to 2008/09 recession, reducing working capital to increase free cash flow and remaining profitable.

A key driver of the company is the ability to innovate or acquire new pillars and leverage technology across industries. The company expects to have an organic sales growth of 2% to 5% in 2013 due to product improvements and new product launches. Over the past 10 years, the company invested, on average, fewer than 6% of its total revenues in R&D. To achieve this growth, 3M will focus on international markets that offer higher long-term revenue growth. It faces high margins in Asia and Latin America, remarking the higher profitability in emerging economies. Also, acquisitions will remain a key driver of the company´s growth strategy. The company has acquired Ceradyne Inc. and FSTech. It is expected that this one’s contribute approximately 1.5% to sales in 2013.

In terms of valuation, the stock sells at a trailing P/E of 18.6x, trading at a discount compared to the industry average of 20.2x, representing a discount of 7.9%. Analysts’ expectations imply a forward P/E of 16.06. At that P/E it seems cheaper compared to the industry average. For the second quarter fiscal year 2013, the company reported strong second quarter results with record quarterly revenue, and year-over-year rise in earnings that beat the Zacks Consensus Estimate by $0.01.

Great Liquidity

Another company that reported strong second quarter results in both revenue and earnings was United Technologies Corp. (UTX). The company is a diversified business conglomerate serving various end-markets such as aerospace, defense and commercial construction. The company is able to invest in longer-term platforms due to its strong cash generation capabilities. The most recent success of this innovation has been Pratt & Whitney's successful re-entry into the narrow-body aircraft engine market.

With almost 20% exposure to emerging markets, this allows the company to remain profitable even during difficult economic times in developed economies. It's a dominant player in the Chinese elevator market, the country that has one third of the world's elevators and is expected to increase much faster than U.S. domestic markets.

Looking at the financials, the company has a strong balance sheet: good cash that allows it to reward current shareholders through dividend and share repurchases. Over the last seven years, the company returned 70% of free cash flow back to shareholders.

Its P/E multiple, on a trailing-12 month basis, is 15.1 and the forward P/E multiple is 15.01. A company characteristic is that it demonstrate its commitment to return cash to investors in the form of dividends. The current dividend yield is 2.06%, which is quite good to protect the purchasing power.

Finally, I always like to see the evolution of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity.

Company ROE Compared to Diversified Industrials industry median (=5.4)
3M 25.3 Above
United Technologies 19.8 Above

Looking at the table we can see that both companies show extremely good ratios.

Final Comment

Even in the throes of recession, industrial activity metrics are starting to show that the industrial economy is expanding. Although United Technologies is expected to grow in emerging markets increasing acquisitions, international markets are subject to economic conditions as well as government regulations. The company is also highly dependent on the U.S. defense budget.

On the other side, 3M seems to be less risky. The increased innovation with good marketing in its business and consumable products should generate higher margins and drive earnings higher, making it the most attractive choice.

Hedge fund gurus like Joel Greenblatt, Jim Simons and Jeremy Grantham added this stock to their portfolios, and I would advise fundamental investors to consider adding this stock to their portfolios as it seems to be an attractive option for investors.

Disclosure: Victor Selva holds no position in any stocks mentioned.

Guru Discussed: Jeremy Grantham: Current Portfolio, Stock Picks
Jim Simons: Current Portfolio, Stock Picks
Stocks Discussed: UTX, MMM,
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