3 Attractively Valued Companies: June 2019

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Includes: AMTD, MMM, TD
by: Jonathan Wheeler
Summary

The market continues its politically-fueled volatility, but hovers right around all-time highs.

Regardless of future market movements, buying strong companies at good valuations will work well over the long run.

These 3 companies look interesting to me at these valuations.

The market has continued to be volatile, with some stalwart companies posting 5%+ daily moves. Based on the news, it would be easy to assume the market has taken a real beating, but it continues to recover to near its highs. The S&P 500 is currently right up next to all-time highs, but in my view, the volatility has been very helpful in bringing some good deals to the surface.

There's something to be said for raising cash in a strong market that has continued for this long. However, it's important to remember that time in the market trumps timing the market, and regardless of overall market valuations, there are always bargains to be found.

With that being said, I want to highlight a few such companies here that I see as trading at relatively attractive valuations with decent long-term growth prospects. That being said, there will always be negatives for any of the companies I am writing about. Generally speaking, if everyone feels really positive about a company, you will be paying for that positivity, which can easily restrict future returns and make downside risk much more likely.

TD Ameritrade (NYSE:AMTD)

TD Ameritrade is a leading online stock broker that just got quite a bit larger with its acquisition of Scottrade. The integration has gone well, by all accounts, with minimal account attrition on the change-over. This is no mean feat, with pretty significant growing pains for investors changing platforms. In an industry plagued by commissions driving towards zero, the companies with the largest moats and economies of scale will rise to the top. TD Ameritrade is one of my picks to be among the brokerages to stay standing when the dust settles. The company has $1.3T in client assets, and 2018 saw 811,000 trades per day, more than its 2 closest competitors combined. Additionally, the company only drives ~36% of revenue directly from trading commissions, and over 30% of that is from derivative trading, which still carries heftier commissions. As an added bonus, Toronto-Dominion Bank (NYSE:TD) owns over 40% of shares, providing steady hands to a significant portion of the company. Ameritrade actually functions as a nice earnings boost for TD, and TD's banking assists TD Ameritrade in many ways, making the relationship a very healthy one. Valuation-wise, a nice jump in earnings and meager price action over the past year plus have led Ameritrade to a nice spot for a current purchase. Zooming further out, Ameritrade has grown earnings well over time, and its dividend has grown at a solid pace since its inception in 2011. The current 2.4% yield is much higher than its 5-year average of 1.6%, and it looks to be well below its long-term average P/E ratio of 21.7X earnings.

Based on analyst estimates of earnings growth and a return to the company's long-term valuation, an investment today would yield over 30% annualized. Obviously, it will take some time for Ameritrade to come back to a ~20X earnings multiple from where it is currently at, if it does at all. 30% annualized returns is not the most likely case for an investment in Ameritrade, but it does show an interesting margin of safety at this juncture.

3M Company (NYSE:MMM)

3M is one of my favorite companies. With that disclaimer out of the way, I didn't own the company until recently and my investment is currently showing a loss of around 13%. Painful? Not really. I waited for quite some time after missing out on buying 3M in the beginning of 2016 at a cyclical low, and after kicking myself, I promised I would grab some for the long haul the next time an opportunity presented itself. Once you look at the valuation graph, you will likely see why I see 3M as a solid opportunity today.

The main reason I like 3M so much is its culture. The company has stood the test of time as a conglomerate, proving in this case that the whole is greater than the sum of its parts. The company manages to invest heavily in R&D and drive higher returns off those R&D dollars by finding as many ways to use its new innovations as possible. Post-it Notes were invented as an accidental byproduct (the reusable adhesive on the back). This culture is a huge competitive advantage, and one of the reasons that I firmly support 3M staying together as a company regardless of the trend towards breaking up the old-line industrials.

The company's size does mean investors should temper their expectations to growth slightly in excess of GDP, with a solid 3.4% dividend that has grown for 61 consecutive years. That dividend is well protected, with $5.7B in free cash flow versus $6.7B in long-term debt for the company. 3M boasts a 24-8% ROIC-WACC spread, an important measure of value creation or destruction through management investment.

That being said, it's not all sunshine and daisies. The company is currently in the early stages of what will likely be an ongoing story of litigation over PFAS in its products, like Scotchgard. Apparently, this chemical can cause multiple health problems, including cancer, and there are reports that a 3M study from 2001 documented this and it wasn't released. I'm not one to speculate on ongoing legal ramifications for a company like this, but there is precedent, and 3M will likely be fine whether or not it does pay settlements.

"The FDA said earlier this week it hasn’t yet seen “any indication that these substances are a human health concern.” Still, it maintains that its understanding of PFAS is still an “emerging science” and that work to understand it is “ongoing.”" (Bloomberg).

3M stated that:

“This report is one of thousands of documents we have placed in the public domain related to the study of PFAS chemistries,” the company said in an email. “We will continue to engage with members of our communities, elected officials and regulators to share information about these chemistries.” (Bloomberg).

Regardless of the outcome, the company started to sell off in advance of this news on fears of a global slowdown. Industrials are cyclical by nature (although 3M's multiple business lines shield it somewhat) and an economic slowdown is just another opportunity to pick up the better companies in the space.

Looking at the short-term valuation, 3M has sold off pretty steeply from its highs. It is currently yielding above its average, and is below its average P/E ratio of ~20X earnings.

Zooming out to a longer view, 3M's current dividend yield is very high historically. It isn't very often an investor can pick up the company over 3% yield. Additionally, based solely on P/E, this is the first time since it looks like 2012 to grab the company this far below its long-term average P/E ratio of ~20X earnings. One thing to notice, as well, is the company's solid earnings growth track record.

Based on analyst estimates of future earnings and a return to the company's average valuation of 20X earnings, an investment today could yield an annualized return of ~14%. This is predicated on restoration of some of the market's current fears about the company. However, in my view, with a company like 3M, I'll just buy it and I'm sure 20 or 30 years from now I won't even remember why it was so cheap when I grabbed shares.

Bank of Nova Scotia (NYSE:BNS)

Anyone who follows me on Seeking Alpha knows about my proclivity to writing about the Canadian banks. They aren't the sexiest investments, and they won't impress people around the water cooler like your recent purchase of Beyond Meat (NASDAQ:BYND), but I consider my Canadian banks to be core holdings to my portfolio.

The Canadian banking system is a state-sponsored oligopoly, with massive barriers to entry, and strict regulations providing for a more conservative financial structure than peers south of the border. The Canadian housing market is more heavily regulated, with responsive laws put in place quickly at the first sign of bubbles (like recent foreign investor laws) to attempt to prevent systematic housing collapses like those seen in America circa 2008.

Canada's housing market, as reported by the Wall Street Journal, is currently shaking off a slump induced by some of those regulations enacted last year, with expected growth of ~1.2% for 2019, an upwards revision from the expected 1.6% decline. BNS' mortgage portfolio has a loan-to-value ratio of ~50% on its uninsured mortgages, and is a leader in the Canadian housing sector.

Source: Company Presentation

The unique aspect of BNS among its peers is its Latin American exposure. Luckily, that doesn't currently include Venezuela, but instead the Pacific Alliance countries. These countries are somewhat more stable, and as shown in the infographic above, have better growth rates than the more established economies in America and Canada. Fully half of the bank's operations are in emerging markets, providing more risk but also boosting potential gains outside of the slower growing Canadian market.

Looking at the short-term valuation graph, BNS is currently trading well off its highs, around the same levels as the oil crash in early 2016 (BNS has significant oil field exposure).

Zooming out to a longer view, BNS is trading at what looks like a pretty significant low historically. Its current 4.92% dividend yield matches up well with its long-term averages, and its ~10X P/E ratio is well below its average of ~12X.

Based on current analyst estimates of growth and a return to ~12.5X P/E, an investment today in BNS could yield and annualized total return of over 22%. Although I see that as unlikely over the short term, I do see BNS returning to its earnings multiple over the medium to long term. Additionally, there is an old adage that an investor can't go wrong buying Canadian banks at 5% yields. This is actually better advice (from my view) than it appears at first glance, since the banks' growth rates and dividend growth is so stable, that over time the banks are relatively cheap when they have yielded 5%. Obviously that is not a hard and fast rule, and I would hope that any investor would do their own research before buying a company based on a saying. That being said, I see BNS as attractively valued today.

I hope this article has been helpful and informative, and as always, do your own research and ensure that the investments you are making meet your own goals prior to making investment decisions. Let me know what you think of these companies in the comments below.

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Financial statistics were sourced from Morningstar, with the charts and tables created by the author, unless otherwise stated.

Disclosure: I am/we are long AMTD, MMM, BNS. 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.

Additional disclosure: This article is for informational purposes only and represents the author's own opinions. It is not a formal recommendation to buy or sell any stock, as the author is not a registered investment advisor. Please do your own due diligence and/or consult a financial professional prior to making investment decisions. All investments carry risk, including loss of principal.