In recent years, conglomerates have started to breakup. While much of 3M (MMM) is truly undervalued, the market is unable to efficiently allocate risk, let alone fully understand the business. In this article, I will run you through a DCF model on the firm and then triangulate the result against companies with similar tech operations, such as Corning (GLW) and Agilent (A). I find that Corning and Agilent are stronger investments than 3M right now.
First, let's begin with an assumption about the top-line. 3M finished FY2011 with a $29.6B in revenue, which represented a 11.1% gain off of the preceding year: deceleration. I model 10.5% per annum growth over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods as 52% of revenue, SG&A as 20.5% of revenue, R&D as 5.4% of revenue, and capex as 4.3%. Taxes are estimated at 28% of adjusted EBIT (i.e. excluding non-cash depreciation charges to keep this a pure operating model.)
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $95.66, implying just 13% upside.
All of this falls within the context of strong operating performance:
"[W]e achieved an all-time Q1 sales record of $7.5 billion. Industrial and Transportation, SS&PS, Health Care and Consumer and Office all performed well, while weakness in Electronics hurt Display and Graphics and Electro and Communications. As we said, we look for the electronics market to pick up as the year goes on.
Geographically, for 3M, the Americas were strong. Asia Pacific was somewhat slower, and Western Europe held its own with very good operational discipline. For the company, operating margins improved to nearly 22%, with 5 out of 6 businesses above 20%. We executed well, and the result was a 7% increase in EPS to $1.59, including a $0.04 charge for a voluntary early retirement program and some miscellaneous restructuring".
From a multiples perspective, however, there are clearly cheaper options. 3M trades at a respective 13.9x and 12.1x past and forward earnings versus 13.4x and 11.3x for Agilent and 8x and 8.4x for Corning.
Consensus estimates forecast Agilent's EPS growing by 9.2% to $3.22 in 2012 and then by 9.9% in both of the following two years. Assuming a multiple of 15.5x and a conservative 2013 EPS of $3.50, the stock would hit $54.25 for a sizable 36.9% upside. Of the last 12 revisions to EPS, all have gone up for a net change of 1.2%. According to NASDAQ, the Street currently rates the stock a "strong buy".
Corning is a riskier investment given earnings volatility. Consensus estimates forecast its EPS declining by 22.7% in 2012 and then growing by 11.8% and 2% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $1.48, the stock would hit $19.24 for 50.1% upside. I believe that Corning is much stronger than what the market appreciates given catalysts in Gorilla Glass, excellent management, and leading positions in key markets.