Industrial heavyweight 3M Company (MMM) reported earnings results earlier this week. Results were mixed, but the company saw improvements in several of its businesses. The stock also offers a dividend yield that is more than a full percentage point higher than its 10-year average yield. As a result of improving business results and a high yield, I recently decided to add to my position in 3M. Here's why.
Quarterly highlights
3M announced its third quarter results on Oct. 27. The company's revenue grew 4.5% year over year to $8.4 billion. Revenue growth was significant compared to the second quarter, when it dropped 12%, but still missed Wall Street's estimates by $30 million. Adjusted earnings per share fell almost 6% to $2.42 but topped expectations by $0.16.
The company also saw a return to organic growth as revenue improved 0.9% in local currency. This was a far cry from a 13% decline in the previous quarter.
Adjusted operating margins declined 90 basis points to 22.9%. Excluding the sale of real estate in the previous year, adjusted operating margins were down just 20 basis points.
North America saw solid growth, with organic sales rising 5%. Asia Pacific was down 3% while the Europe/Middle East/Africa region was flat year-over-year. Each result was much better on a sequential basis. Second quarter organic growth decreased more than 15% in North America, declined 14.5% for EMEA and was lower by 8.1% in Asia Pacific. China sales were especially strong as overall growth was 8%, with each segment higher by at least 6%.
Safety & Industrial sales were higher by almost 7% to $3 billion. This segment saw growth in personal safety, roofing granules and automotive aftermarket products. Offsetting this was a weak market for electrical materials, industrial adhesives and takes and abrasives. As these products are often in greater demand with an improving business environment, it is not necessarily a surprise these product categories were weak. This segment had double-digit growth in the Americas. Segment margins grew 4.3% to 27.2%.
Health Care sales grew 8.1% to $2.2 billion. Medical solutions was the real star as this business was higher by a mid-teens percentage due to demand for disposable respirators. The company has distributed 1.4 billon respirators through the first nine months of the year with a goal of 2.4 billion by the end of the year. Other areas of strength included oral care and separation and purification product lines. Food safety remains challenged due to low traffic. Segment margins fell 3.2% to 23.5%.
Consumer sales were higher by 5.5% to $1.4 billion. 3M has seen solid demand for home improvement and home care products. Both categories had double-digit growth rates as consumers upgrade their homes while social distancing. This has been countered by lower sales for stationery and office supplies.
Transportation & Electronics was down 7.1% to $2.3 billion. Electronics fared well, but all other businesses suffered a decline in organic sales. Auto OEM was down 4%, but this business has outperformed the global market. Hospitality, oil and gas and highway infrastructure were all weaker due to low customer demand. Cost controls enabled margins to drop just 1.5% to 23.9%.
3M said that certain businesses, such as personals safety, home improvement, data centers and biopharma filtration, remain strong into the month of October. On the other hand, health care elective procedures, automotive OEMs and general industrial continue to feel the effects of Covid-19.
Lastly, 3M saw improvements in its balance sheet. Adjusted free cash flow was up 13% to $2.2 billion for the quarter. Year-to-date, adjusted free cash flow is higher by 19% to $4.6 billion. 3M ended September with $4.6 billion in cash. The company also retired $1.3 billion of debt during the third quarter. For the year, 3M has paid down $2.8 of debt, reducing its total amount by ~16% in 2020 alone.
While 3M isn't out of the woods yet with regards to all of its businesses, I feel much more comfortable about the company's direction today then I did after the second quarter.
Valuation
3M isn't providing guidance for the remainder of the year, citing the ongoing pandemic, but analysts surveyed by Yahoo finance expect EPS of $8.50 for 2020, up from prior estimates of $8.18.
Using analysts' expectations for the year, the stock has a forward price-earnings ratio of 19.2 at the time of purchase. This is slightly higher than 3M's 10-year price-earnings ratio of 18.4, but below the five-year average price-earnings ratio of 20.9.
In addition, the GuruFocus Value chart estimates that 3M is trading below its intrinsic value.
The GF Value is estimated to be $181.58. The stock's price-to-GF-Value for my purchase price is 0.90, earning the stock a rating of moderately undervalued. Reaching this price would mean an 11%+ gain from where I added shares.
At the same time, 3M's dividend yielded 3.6% at the time of purchase. The stock's 10-year average yield is 2.6%, 100 basis points below the current yield. 3M's current yield is quite rare for the stock. Only once since 2004 has 3M averaged a yield of at least 3% for an entire year (in 2019).
Final thoughts
Headwinds related to the pandemic remain in multiple end-markets for 3M, but three out of four business segments produced growth in the quarter. Multiple business lines also responded well in the quarter. 3M is also seeing solid cash flows while reducing its debt burden at the same time.
Shares of the company appear to be undervalued, both against its five-year historical average and the GF Value chart. Add a yield that is considerably higher than usual and my decision to increase my stake in 3M was easy to make.
Author disclosure: the author has a long position in 3M Company.
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