By their very nature, conglomerates are often hard for investors to value. The trend in the activist investing space has rightfully been towards breaking up firms into relevant pieces. I proposed this for 3M (MMM) here while Tyco (TYC) progresses to breaking up into three publicly-traded companies. Based on my review of the fundamentals, DCF model and multiples analysis, I find that the two have reasonable room for appreciation.
From am multiples perspective, 3M is the cheaper of the two. It trades at a respective 14.7x and 12.7x past and forward earnings, while Tyco trades at a respective 16.5x and 11.9x past and forward earnings. To put this into perspective, consider that both firms are roughly valued at their 2 Digit MG Group average PE multiple. The Street currently rates Tyco a "buy" versus a "hold" for 3M.
At the first quarter earnings call, Tyco's management noted solid performance:
We are off to a solid start to 2012, highlighted by strong operating margin performance. Growth in our large and stable base of recurring and service revenue, which represented 45% of our revenue in the quarter, coupled with good operating leverage in our manufacturing businesses, helped drive the operating performance this quarter. Additionally, we continued to benefit from our restructuring and cost containment initiatives, which also contributed to the 100 basis point improvement in operating margin year-over-year.
We exited the quarter feeling encouraged by both our performance and our order activity. It's important to keep in mind that our North America residential business, which represents about 20% of total revenue, has continued to achieve quarterly organic revenue growth over the past several years, including the period throughout the economic downturn. From an orders perspective, order growth relates to the remaining 80% of our portfolio, which has continued to see positive momentum.
First quarter results were strong, with EPS of $0.84 solidly beating expectations by 6.3%. Order momentum has improved, gaining 8% y-o-y as revenue grew by 4% organically. Security Solutions, Fire Protection and Flow Protection are well-positioned, moreover, for further organic growth. The company is relatively safe, given how much of the cash flow is recurring. Splitting into three publicly-traded companies will help shed light on this strength by improving transparency. The breakup will be completed by 2012's end.
Consensus estimates for Tyco's EPS forecast is that it will grow by 12.3% to $3.64 in 2012, and then by 13.5% and 12.1% in the following two years. Modeling a 3-year CAGR of 12.6% for EPS and then discounting backwards by a WACC of 9% yields a fair value figure of $58.77, implying 19.8% upside.
3M, similarly, had a strong close to the year with record sales and production adjustments in consumer electronics. Fourth quarter earnings per share beat consensus by 3%. Display & Graphics still has a significant degree of certainty due to shaky demand for optical systems. Despite generally strong top-line momentum across the board, ROIC is only expected to increase nominally over the next two years, limiting value creation.
Consensus estimates for 3M's EPS forecast is that it will grow by 5.5% to $6.29 in 2012, and then by 9.7% and 9.6% in the following two years. Assuming a multiple of 14.5x and a conservative 2013 EPS of $6.84, the rough intrinsic value of the stock is $99.18, implying 13.2% upside.