Why 3M Is Heading To $150

Apr.23.14 | About: 3M Company (MMM)

Summary

While some will complain about 3M’s stock price, the valuation has not diverged too much from General Electric, Honeywell and Danaher.

With the stock trading at around $137, 3M shares should command a market value of $150 on the basis of improved margin and cash flow.

For the next three years, management has projected 9% to 11% growth in earnings per share and 20% return on invested capital.

Regardless of how long you wait for a "good" entry price, it seems that some stocks just never get cheap. Very seldom does the stock of good companies fall below their fair-market value. 3M (NYSE:MMM), which is mostly known for its Post-it notes and Scotch tape products, certainly fits that category. Over the past two years, the stock has soared close to 70%. Remarkably, the industrial conglomerate has done this even amid complaints about the company's margins.

Now the talking points have changed. Some are now proclaiming the stock as too expensive. Some are arguing that since 3M has posted such strong gains, it's now time to sell the stock in favor of 3M's rivals, many of which have not fared as well. While I do believe in skating to where the puck is going to be, it's foolish to dump a strong-performing stock when fundamentals have not changed.

3M has demonstrated a strong track record for innovation and operational efficiency. And with strong-performing businesses in areas like healthcare, electronics, energy, safety and so on, these shares still won't get cheap anytime soon. With the company due to report first-quarter earnings results Thursday, management will once again "post" a reminder for why 3M deserves the respect it has received.

Although estimates have fallen over the past 30 days, analysts remain optimistic about 3M's results. On Thursday, the Street will be looking for earnings per share of $1.79, which is expected to jump 11% year over year. Last year, 3M posted earnings per share of $1.61. For the full fiscal year, analysts are expecting earnings of $7.47 per share. I think some more context of these numbers is required.

Recall, in the January quarter, 3M posted a 2% profit decline. As noted, this spawned the narrative about "repeated margin weakness" in 3M's various segment. But these concerns were exaggerated. While margins haven't been up to the company's historical standards, management has consistently matched its guidance both on a reported and incremental basis.

Besides, 3M's results have never swayed that drastically from other conglomerates like General Electric (NYSE:GE) and Honeywell (NYSE:HON). And while it was disappointing that the company posted a decrease in profit in the fourth quarter, I also can appreciate that 3M has posted profit increases in the two quarters prior. The company posted 6% increase in the third quarter and 3% increase in the second quarter.

In terms of revenue, analysts will be looking for $7.96 billion, which should exceed last year's mark of $7.63 billion by 4%. For the full year, revenue is projected at $32.35 billion, which will be good enough for 5% year over year growth. Also note, prior to the revenue decline in the fourth quarter, 3M had achieved revenue growth in the preceding three quarters.

As much as Wall Street seems to be obsessed over quarterly results, buying 3M, which is one of the best defensive stocks on the market, is about the long term. To that end, even if these numbers were to come inline or slightly below, that's not where the value in these shares are.

Consider, for the next three years, management has projected 9% to 11% growth in earnings per share and 20% return on invested capital. When you combine this performance with a company that's already producing high-single-digit growth in free-cash-flow and a recent 35% dividend increase, you have a premium brand that is appropriately priced.

From my vantage point, while some will complain about 3M's stock price, the valuation has not diverged too much from General Electric, Honeywell and Danaher (NYSE:DHR) - all of which trade near their 52-week highs. And given management's viable long-term strategy in place, 3M still looks like a bargain on a long-term basis. The company should have no problems accelerating growth as the global economy continues to improve.

All told, this is a strong company with a global reach that can still grow at mid-single digits. With the stock trading at around $137, 3M shares should command a market value of $150 on the basis of improved margin and cash flow. My target is $10 shy of the analysts' highest mark of $160. But should 3M report higher comps on Thursday and improved guidance, I'll have to reconsider.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's tech sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.