3M (NYSE:MMM) announced 4th quarter earnings this past week that beat the street's estimates by $0.03 per share. The company posted $1.66 in EPS on revenue of $7.3 billion. The street had forecasted the company to generate $1.63 in EPS on $7.21 billion. Post announcement the stock popped by 5%, trading up to $144 per share. The current price of the stock now hovers around $152 per share and is still 12% below the stock's 52-week high of $170 per share that was achieved in the early part of 2015.
In addition to the stronger than expected numbers, 3M also announced a new $10 billion share buy-back program that would be coupled with an 8% increase in the dividend payout.
3M currently trades for around $152 per share or 17X forward earnings. This current pricing in the stock I feel is not factoring in all of the potential future growth and shareholder value that the company plans to return in the coming year(s). To better understand what 3M's true stock price should be trading at I will use one of Benjamin Graham's Intrinsic Valuation models.
Before we dive into the model we must first understand some of the fundamental impacts that 3M's new buy-back is going to have on the fundamentals of the company. Currently 3M has 609 million shares outstanding, a market cap of $92.5 billion, and a book value of $19.28 per share. Now for the purposes of this article let's assume that 3M is able to buy their stock back for an average price of $150 per share. The total share repurchasing with an average price of $150 would decrease the existing share count to 542 shares. This would increase the company's book value (all things remaining equal) to $21.67 per share or 12.4% and will increase future EPS even if revenue remained flat.
Coming off of 3M's last buy-back that was announced back in 2013 the financing of this buy-back is all being done through its steady stream of free cash flow. For the past three years 3M has generated between $4 - $5 billion in free cash flow annually, given the trend that has been outlined in Cash Flow statement I think it is fair to assume that the new $10 billion buy-back will be broken up over the next two and half years, especially given the amount of free cash flow that is available.
· 2015 - $4.95 B
· 2014 - $5.13 B
· 2013 - $4.15 B
Capital expenditures for this coming year of 2016 are expected to be in the range of $1.5 - $1.3 billion. Assuming an average of $1.4 billion and cash from operations growing at the low end of the project EPS guidance of 7%., cash from operations would end the year around $6.87 billion. This would put 2016 free cash flow at around $5.47 billion. This is all predicated on the fact that 3M is anticipating its free cash flow conversion to be the range of 95% to 105%.
In addition to the buy-back and stronger free cash flow it is important to also mention that large increase that is about to occur with the dividend. The dividend was increased to $1.11 per share per quarter, up from the previous $1.025. This increased dividend creates a yield for 3M of almost 3% and should create somewhat of floor in the stock price for income investors.
All of these actions taking by the company are great, but what is 3M's real value given these changes. The market this week seemed to like the changes and set shares up, but some of that increase could have been attributed to the positive action seen in the broader indexes. To get to the bottom of this I want to try and determine 3M's intrinsic value by leveraging both the company's most recently provided guidance and metrics.
As I said earlier in the article I plan to us Benjamin Graham's intrinsic valuation model. See inputs below.
Intrinsic Value = (EPS X (8.5 + 2g) X (C/T)
· Trailing EPS - 7.58
· 8.5 - Graham's assumed P/E for a no-growth company
· Long Term Growth (5 years) Rate (NYSE:G) - 6.30%
· AAA 20 Year Corporate Bond Yield (NYSE:C) - 3.73%
· 30 Year Treasury Yield (NYSE:T) - 2.67%
Putting the above inputs into Graham's formula would generate an intrinsic value for 3M of $222 per share. This represents an implied increase in value of 46% from the average trading price of $152 per share today.
Now, the above formula is Graham's revised formula from 1977 where he added in a bond ratio to the model to account for broader market factors and risk premium. Since the original formula did not include the bond yield ratio, if I were to remove it from the equation the updated intrinsic value of 3M would be roughly $160 per share. This compared to the current price of $152 today and would suggest that the market is fairly valuing 3M, which I don't feel is completely accurate.
An additional metric that can be applied to the above model is for us to take into consideration the effect that the buy-back will have on the EPS going forward. Building off of the assumptions made at the beginning of the article, assuming that the share float was decreased by 67 million shares (via the buy-back) the trailing EPS of 7.58 on $4.83 billion in net income would instead be 8.91 per share. Applying that number in the above formula would then give us a new intrinsic value of $190 per share. This would represent a premium to current prices of 18.4% and I think is an accurate valuation of a company that is both growing its earnings, free cash flow, and shareholder returns.
Overall 3M looks to be undervalued and the better longer term play against some of its key competitors like Honeywell (NYSE:HON), General Electric (NYSE:GE), and United Technologies (NYSE:UTX). Looking forward I would expect 3M to begin to close that gap and trade up toward the $180 - $220 range or splitting the difference $200 per share. I would suggest buying 3M at current valuations and holding it until it reaches $200 per share. There I would reassess the fundamentals of the company using similar models and determine if further upside and growth was still achievable.
Disclosure: I am/we are long MMM.
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.