3M: What Are You Paying For?

| About: 3M Company (MMM)

Summary

3M is a multinational company with a highly diverse portfolio.

Revenues have remained stagnant since 2012, and net income growth has come mainly from margin expansion.

Despite its diversified portfolio, its current valuation seems generous.

In my prior piece on 3M (NYSE:MMM), I discussed the company's wide economic moat and the current macroeconomic headwinds it faces. I recommended that investors should stay away from the stock, unless they were a retiree looking for a stable company that offered a consistent dividend yield.

Following a correction from its high of ~$160 in November and December to its current price of $140, it is prudent to evaluate whether market conditions present a buying opportunity. While I love the company underlying the stock, I believe that 3M is still overvalued given its limited growth profile.

Financial Performance

3M has barely moved the needle on revenue over the past five years, with EPS growth attributable to margin expansion.

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Management has done good work expanding margins, but using that as a means to build net income is unsustainable. When it comes to commodities, input costs for their products are at the lowest in a long time. Management is forecasting a 30 basis point increase in margins for FY2016, with only a tepid 1.2% increase in revenues. While the company is delivering strong performance in a weakening macroeconomic environment, I do not believe this growth in net income is enough to justify the premium attached to the stock.

Valuation & Headwinds

The company trades at a forward P/E of 17, with a dividend yield of 2.82%. It also trades at 13x 2016 estimated cash flows, and a Price/Book ratio of 9. Compare that to the S&P 500, which trades at a forward P/E of 15.5. While this premium is not significantly out of line given the diversity of 3M's revenues, I argue it is still substantial given macroeconomic headwinds 3M faces. Over 25% of their revenues come from the Asia Pacific region, which faces volatility and slowing growth. Additionally, the strength of the dollar continues to threaten repatriation of foreign revenues. In 2014, More than $20b out of 3M's $32b of revenue came from overseas. If the dollar continues with such strength, that would be a substantial risk to 3M's profitability.

Conclusion

I pose the question again: When you buy 3M, what are you paying for? You're obviously getting a great company with shareholder-friendly management, with a well diversified base of products and geographic locations. However, 3M has demonstrated a limited capability to grow revenues over the past five years, and margin improvement is not a sustainable path forward. Given macroeconomic headwinds, an already-existing premium over the S&P 500, and sub-3% dividend, I see little opportunity for growth in share price combined with a low reward for holding the stock in your portfolio.

All data is sourced from a Bloomberg Terminal unless otherwise stated.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.