The last time I discussed 3M Co. (MMM, Financial), I felt the stock was a solid buying option as the fundamentals were improving. Following several years of declining organic growth combined with the pandemic, 3M appeared to be emerging from the wilderness as a stronger company.
The stock was also trading at a higher-than-usual dividend yield.
That business momentum continued into the most recent quarter, but the stock is down almost 11% from the time of my last look at the compay. The yield is even juicer today than it was then, and the valuation is even more appealing.
For investors looking for a entry point into the name, 3M looks like a good buy at current levels.
Earnings highlights
The industrial conglomerate reported second-quarter earnings results on July 27. Revenue surged nearly 25% to $8.95 billion, topping Wall Street analysts' estimates by $371 million. Net income of $1.5 billion, or $2.59 per share, compared favorably to net income of $1.3 billion, or $2.25 per share, in the prior year. GAAP earnings per share also came in 34 cents better than expected.
Growth was seen everywhere in all geographic regions in all business segments. Organic sales grew 21.4% in local currency and all of 3M’s business segments had at least 17% organic growth.
Safety and Industrial, the largest individual segment, grew 22.4% (or 17.6% organically) to $3.3 billion. The industrial, electronics, construction and automotive aftermarket businesses continue to perform well. Disposable respirator sales, while up 3% year over year, decreased 11% compared to the first quarter of 2021 due to slightly lower Covid-19 related demand. One item of note was that higher input costs reduced the operating margin by 1.3% to 22.1%.
Transportation and electronics improved 28.1% (or 24.2% organically) to $2.5 billion. Automotive original equipment manufacturer was the prime driver of growth. Semiconductor demand also remains elevated as the recovery from the pandemic continues. The operating margin expanded 340 basis points to 22% despite higher raw material costs.
Health care grew 24.9% (or 23.2% organically) to $2.3 billion. Higher patient visits to dental offices led to gains in oral care and an increase in elective procedures has caused greater demand for medical solutions. Food safety was up due to higher food service demand. The operating margin was up nearly 900 basis points to 25.3%
Consumer grew 20.4% (or 17.8% organically) to $1.5 billion. This segment was the prime beneficiary of the return to school and work trend that began to occur in the quarter. Results were higher almost across the board, especially for office, stationery, home improvement and cleaning. The operating margin did retreat 160 basis points to 21% due to higher material costs and advertising spend.
Leadership provided revised guidance for the year. 3M is now expected to produce organic revenue growth of 6% to 9% for 2021, up from 3% to 6% previously. Earnings per share is now viewed as achieving a range of $9.70 to $10.10, up from $9.20 to $9.70 previously. At the midpoint, this would be a 13.1% increase from last year.
Takeaways and valuation analysis
As with many companies, 3M’s second quarter is being compared to its weakest period of 2020, when the pandemic was at its height and consumers and businesses were adjusting to a new way of operating. Still, the company easily surpassed analysts’ estimates that were already pretty robust.
Going back to the second quarter of pre-pandemic 2019, revenue grew 9.5% and net income and earnings per share were both up 35%. Guidance for 2021 also implies a nearly 9% increase in earnings per share relative to 2019. So while 3M did topple year-over-year estimates, the company appears to be in a stronger position that it was even in 2019. This speaks to the quality of the company that it was able to not only survive the harsh 2020 environment, but come out in a better position financially than it was prior to the pandemic.
Much of this is due to the strength of 3M’s diversified business model and market leadership in its respective categories. The company is also one of the more innovative names in the marketplace. It spends approximately 6% of sales on research and development every year, which has led to a portfolio that exceeds 100,000 patents. Research and development spend has been so successful that nearly a third of sales come from products that didn’t exist five years ago.
3M has also benefited from the reopening of society since the worst parts of the pandemic. Schools are largely open across the U.S. and businesses are starting to bring back workers into the office. As more schools reopen this fall, then this area of the company should also see a benefit from higher demand. Restaurants and other food service venues are reopening as well and elective medical procedures have seen an uptick in number performed. The company’s consumer and health care segments were direct beneficiaries of this reopening and somewhat return to normalcy.
Offsetting these positives is that inflation is impacting multiple businesses, most notably in the safety and industrial and consumer segments. This isn’t likely to ease in the near term. 3M initially guided toward of a headwind from higher input costs that would reduce earnings per share by 30 cents to 50 cents for the year. The company now expects that charge to be a in range of 65 cents to 80 cents, with much of this pain to be felt in the back half of this year. Raw material cost increases reduced earnings per share by 17 cents and lowered the operating margin by 140 basis points in the second quarter.
In order to offset this, 3M will likely raise prices where it can. The company has also undertaken a restructuring program that will reduce its costs, but be a pre-tax charge of $60 million to $110 million.
Even when factoring in the inflation headwind, leadership expects that earnings per share for the year will be the second-highest in the company’s history after 2018. This is an impressive accomplishment in the face of rising costs.
Despite the positives, shares of 3M have traded downward since the earnings release. Using the current share price of $185 and the midpoint for 2021 guidance, 3M has a forward price-earnings ratio of 18.7. According to Value Line, this multiple is just below the 10-year average price-earnings ratio of 18.8 and is a discount to the five-year average price-earnings ratio of 20.5. Using the two valuations as a range, shares could reach $203 if they were to trade at the high end. Shareholders could see a 9.1% gain from current levels if this were to occur.
In addition, total returns would include the company’s dividend, which has been raised for more than six decades. The yield stands at 3.2% presently, topping the yield of 2.7% that the stock has averaged since 2011.
Add the potential gains from share price appreciation to the yield and total returns could reach into the low double-digit range.
Final thoughts
3M turned in a second quarter that not only topped last year’s results, but also that of second-quarter of 2019. The company appears to have turned the corner from Covid-19 and is stronger than it was before the pandemic. Inflation will be an issue, but expectations for the year are strong against even pre-COVID-19 results. With double-digit total return potential, a long history of dividend growth and a higher-than-usual yield, 3M is a stock that investors should consider owning.
