3M - While I Share Optimism Displayed By Argus, This Is Not The Time To Buy

|
 |  About: 3M Company (MMM)
by: The Value Investor

Summary

Research firm Argus turns bullish on 3M.

Sales growth, margin expansion and share repurchases create potential for years of future double-digit EPS growth.

Yet margin of safety is limited at current premium levels.

Shares of 3M (NYSE:MMM) held up relatively well on Tuesday amidst a wider market losing some ground. The main reason is an upgrade from analysts at Argus, who argue that the company deserves a premium valuation.

I share the long-term optimism as displayed by Argus, yet I am not in a rush to buy shares at current elevated levels. If the company executes on the outlined growth path, shares offer appeal, yet I think shares offer relatively little margin of safety at current levels.

Argus Turns Bullish

Analysts at Argus have turned more optimistic on 3M's prospects, hiking the rating from hold to buy.

Argus believes that 3M can continue to deliver mid-single-digit sales growth. This alongside targeted margin expansion and share buybacks should result in low double-digit earnings per share growth.

The focus on creating shareholder value is apparent given the recent aggressive dividend hike. Continued improvements in the global economy and the focus on new products through innovation should be drivers behind the increase in topline sales results.

Argus acknowledges that shares are not necessarily cheap, yet 3M warrants a premium compared to its industrial peers for the reasons outlined above.

Recent Developments

Back in May, 3M presented itself at the Sanford Bernstein conference. The company outlined its vision in which its new products, technologies and innovation would improve our homes, companies and lives.

The company is of course well-diversified and looks to expand its customer base and its presence in the marketplace. The company furthermore aims to gain market share, focus on innovation and benefit from long-term megatrends. All of this should be driven by a focus on operational excellence, being accretive to already solid margins.

While of course the big industrial activities make up roughly a third of total revenues, 3M has large operations in health care, consumer, safety & graphics and the electronics & energy market. It expects sales growth in all of these markets somewhere in the mid-single digits.

Last year, 3M generated about 35% of its sales in developing markets. An 8-12% targeted organic growth rate in the period 2013-2017, should push this percentage to 40-45% by 2017, with developed markets expected to grow between 2 and 4% per annum.

To propel growth, 3M aims to increase research & development efforts from 5.6% of sales currently towards 6.0% by 2017. Besides the focus on organic growth, 3M clearly states that merger & acquisitions will be used to complement growth, being focused on high growth and technology areas.

All of this should result in organic growth of 4-6% between 2013 and 2017. Earnings per share are seen up between 9-11% per annum over this time period. Based upon this guidance, revenues are seen between $37-$38 billion by 2017, with earnings per share anticipated around $11 per share on a diluted basis.

Current Valuation

Back in April, 3M released its first quarter results. The company ended the quarter with $2.8 billion in cash, equivalents and marketable securities. Total debt excluding certain pension liabilities stood at roughly $6.6 billion, resulting in a net debt position of about $3.8 billion.

On a trailing basis, 3M posted sales of $31.1 billion on which it net earned $4.7 billion. Around $145 per share, 3M's equity is valued at $95 billion. This values equity in the business at 3.1 times sales and 20-21 times earnings.

3M currently pays a generous dividend of $0.855 per quarter, for an attractive yield of 2.4%.

A Look At The Past, And The Future

After 3M's shares have been largely stagnant in the period 2000-2010, shares have seen strong momentum in recent years. Until 2012, shares have largely traded in a $70-$90 trading range, but very strong momentum in 2013 and earlier this year sent shares to current highs of $145 per share.

Underlying these returns is the accelerating revenue growth, margin expansion and share repurchases, with investors chasing for yield in today's economic environment. The company hiked its quarterly dividend by nearly 35% to $0.855 per share earlier this year.

This marks the 97th year in which 3M has been paying dividends on a consecutive basis. It also marks the 56th consecutive year in which the company has hiked its dividend. On top of these attractive dividends, 3M expects to repurchase another $4 billion worth of shares this year, while returning a total of $17.5 to $22 billion through share repurchases between 2013 and 2017.

Final Takeaway

As research firm Argus mentions, 3M indeed trades at a premium multiple around 20-21 times earnings, while the balance sheet is relatively solid.

Of course a large part of the recent momentum, after shares have risen 30% over the past year, is driven by the future guidance. Based on the targets for 2017, 3M would trade at 2.6 times sales and 13-14 times earnings.

As such, investors are currently attaching a premium valuation, based on the attractive roadmap laid out by management for the coming four years. If the company can execute, the company will grow into the valuation. On the other side, the targets are based on relatively solid economic conditions and favorable margin targets, which creates risks if the global economy might take an unexpected turn for the worse.

Therefore, I like the shares, but not necessarily at current levels which leave little margin of safety in my opinion. I am a buyer around 18 times earnings, which is on par with the wider market. This would translate into a $125-$130 entry point, making me a patient potential buyer on the sidelines.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.