Since I first argued here that General Electric (GE) was more undervalued than 3M (MMM), the former has soared 935 bps higher than its competitor at a return of 15.2%. The Street now rates shares of 3M a "hold" and those of GE near a "strong buy". Based on my multiples analysis and DCF model, I find that both companies are trading around intrinsic value.
From a multiples perspective, the two are more or less fairly priced. 3M trades at a respective 14.6x and 13.6x past and forward earnings while GE trades at a respective 15.7x and 12.4x past and forward. GE may offer a dividend yield that is around 100 bps higher at 3.6%, but it comes at the cost of more volatility. I see limited, if any room, for multiples expansion for both industrials.
At the third quarter earnings call, 3M's CEO, George Buckley, noted reasons to be optimistic about the company despite macro uncertainty:
In the last few months, worldwide IPI forecast for 2011 have fallen by 4,200 basis points. This a reset down in expectations of the global economy. Those who know our company well know 2 things always happen in these circumstances. First, that change is always amplified in the supply chain, temporarily suppressing net growth. And second, we always see the effect early, typically 1 to 2 quarters before our industrial peers. Without these factors or transients, our underlying organic growth would have been almost 6%, so underlying fundamentals are okay. The best in news is this: Electronics markets always recover quickly and early from these types of slash contractions, as do we.
Third quarter results were disappointing with lower-than-expected end market demand, particularly in tablets. Display & Graphic may further decline in the double-digits y-o-y during the third quarter due to continued structural issues. The company recently acquired the office / consumer products business of Avery Dennison (AVY) in an all-cash deal valued at $550M. The expected close is in the second half of 2012 and it will be roughly $0.06 dilutive to EPS for the twelve following months. Thereafter, the acquisition will be $0.06 accretive, mostly as a result of cost synergies. Management is optimistic about the transaction's ability to reduce SG&A on a proportional basis.
Consensus estimates for 3M's EPS forecast that it will grow by 2.8% to $5.91 in 2011 and then by 6.6% and 7.9% more in the following two years. Assuming a multiple of 14x and a conservative 2012 EPS of $6.15, the company is fairly valued. This is further confirmed by modeling a CAGR of 5.8% for EPS over the next three years and then discounting backwards at a WACC of 9%.
GE, similarly, is trading around intrinsic value. The company has de-risked operations by shifting away from financials and more towards infrastructure. GE Capital is likely to continue to struggle given uncertainty in the capital markets and poor trends in real estate. A transition to energy and technology, specifically, will benefit the firm given the solid fundamentals in this area.
Consensus estimates for GE's EPS forecast that it will grow by 19.1% to $1.37 in 2011 and then by 13.1% and 14.8% more in the following two years. Assuming a multiple of 12.5x - more than reasonable - and a conservative 2012 EPS of $1.48, the firm is fairly valued. Even still, analysts rate the company near a "strong buy".