The Fed is currently supporting the US economy which has led to the share price/valuation of many companies to be at levels which are unsustainable if Fed support is ever reduced/withdrawn. In my opinion, investors would be wise to dial back risk.

3M (MMM) is profitable and generates positive Free Cash Flow. Its current valuation is attractive and is at its lowest level since FY2012.

Summary

  • The Fed is currently supporting the US economy thus reducing investor worries around corporate profits during these challenging times.
  • Support from the Fed cannot continue in perpetuity and bond/equity values will likely suffer when there is an indication that support will be withdrawn.
  • Investors should be dialing back risk exposure.
  • MMM continues to generate positive Free Cash Flow and credit rating is investment grade.
  • Current PE level in the upper teens is the most attractive valuation since 2012.
  • Investors get rewarded with a safe and attractive dividend.

Introduction

In recent articles (here and here) I indicated my intent to help:

  • my daughter build her investment portfolio;
  • her boyfriend start an investment portfolio.

Both are in their early 20s and with time on their side I want them to start building respectable portfolios NOW! Starting when their careers are established is, in my opinion, far too late.

Over the course of several years, my daughter has accumulated shares in:

  • Alimentation Couche-Tard Inc. (ATD-b)
  • BCE Inc. (BCE)
  • Brookfield Asset Management Inc. (BAM-a)
  • Brookfield Business Partners L.P. (BBU.un) – units were received when spun off from BAM
  • Mastercard Incorporated (MA)
  • Stryker Corporation (SYK)

While some may argue we should be adding technology companies to her portfolio given her long-term investment time horizon, I am reminded of the dot.com craze when I look at the current valuation of many technology companies.

Not only I am reluctant to invest in high tech companies with lofty valuations, I cannot bring myself to invest in unprofitable companies and/or companies which are not generating Free Cash Flow regardless of their potential.

Furthermore, I fall in the camp that bond and equity values are being propped up by the Fed and that this propping up cannot go on in perpetuity. If/when Fed support is reduced/withdrawn, I envision a pullback from the stock values we are witnessing today; I certainly do not want to find myself with any exposure to companies which I deem to be of inferior quality.

As an example, Carnival Corporation (CCL) recently issued debt bearing an 11.5% rate of interest. With risk free rates hovering not much above 0% you must realize that an investment yielding 11.5% is highly risky. My tolerance for risk is such that I have no desire to invest in a company generating virtually no revenue where there is a strong probability that the attractively priced bonds stand an above acceptable probability of going in default.

Key Ratios

Looking at a company’s operating performance is highly important. Regretfully, I strongly suspect many investors totally disregard any form of financial analysis before investing in a company. This, in my opinion, is a recipe for disaster…especially in our current environment.

The following are a few very, very basic metrics for MMM.

Gross Margin during the 2010 – 2019 timeframe (in % terms): 48.12, 47, 47.55, 47.83, 48.31, 49.19, 50.05, 49.46, 49.09, 46.68 and a trailing 12 month level of 47.65.

Operating Margin during the same timeframe (in % terms): 22.2, 20.86, 21.68, 21.59, 22.42, 22.94, 23.99, 22.85, 20.33, 18.86 and a trailing 12 month level of 20.38.

Net Margin is reasonably consistent with a trailing 12 month level of 15.37 and a 5 year everage of 15.78.

The company’s current ratio (current assets/current liabilities) as at the end of Q1 (March 31, 2020) was ~1.65:1 and is relatively comparable to historical levels.

Credit Ratings

In the mid 1990s when I initiated a 3M Company (MMM) position, Moody’s rated the company’s senior unsecured long-term debt as AAA (Prime). Over time, MMM’s rating has been gradually downgraded to the current A1 (top tier of the upper medium grade); S&P rates MMM’s senior unsecured long-term debt as A+ which is equivalent to Moody’s rating.

Although MMM’s credit rating has been downgraded several times over the last couple of decades, the current rating is acceptable for my purposes and I do not envision MMM will default on its obligations any time soon.

Valuation

Based on my analysis of MMM, I have decided to increase our exposure to this conglomerate by initiating a position for one of our daughter’s investment accounts.

MMM withdrew its FY2020 guidance when it released its Q1 2020 results (presentation) but for the sake of determining whether it seems to be reasonably valued, I will use what I deem to be a conservative $2.05/quarter EPS over the next 3 quarters (it generated $2.22 in Q1 2020). On this basis, I think MMM will generate $8.37 for FY2020.

With shares trading at ~$146.26 as I compose this article, this means MMM’s forward PE is ~17.48.

Looking at MMM’s historical PE levels I see MMM’s 2010 – 2019 PE levels of 15.33, 13.90, 14.69, 21.54, 22.54, 19.46, 22.49, 26.27, 25.54, and 20.93.

Based on my earnings estimate for FY2020, the current PE certainly looks attractive relative to recent historical levels.

Dividend and Dividend Yield

MMM’s dividend history can be found here and its stock split history can be found here.

Looking at MMM’s dividend growth between 2002 – 2019 we see the following:

We see wide swings in the annual growth rate of MMM’s dividend with nominal growth during The Financial Crisis. Given the current environment I suggest investors temper their expectations and should not be surprised if we see dividend growth in the 2 – 3% range for FY2021.

As for the present, I expect MMM will leave the current $1.47/quarter in place for the remainder of FY2020 ($5.88 for all of FY2020). On this basis, MMM’s current dividend yield is ~4% which exceeds levels in my previous MMM articles.

The shares I have acquired for my daughter are held in a non-registered account, and therefore, the dividend payments will incur a 15% withholding tax. The net annual dividend per share my daughter can expect to receive over the next few quarters will be ~$5.00/share which represents a ~3.4% dividend yield based on the current $146.26 share price.

Shares acquired today will not be eligible for the June 12th dividend.

Final Thoughts

Although MMM may have limited appeal to investors seeking companies with meteoric growth potential, I do not think the current economic environment is one in which to take on an elevated level of risk.

Keep in mind that MMM is a materials science company where a legion of engineers improves everyday products down to their basic chemistry. By investing in MMM an investor gains exposure to a company with an ability to remain ahead of GDP based on its suite of innovative products that are a by-product of its R&D efforts.

I certainly find MMM to be an appealing investment because it has demonstrated its ability to adapt its technology into multiple use cases which:

  • gives it economies of scope;
  • helps reduce overall unit costs.

In my opinion, by investing in MMM you:

  • can expect to receive a reliable source of increasing dividend income;
  • stand to benefit from capital gains potential given its current attractive valuation;
  • invest in a company with an acceptable level of risk.

I hope you found this article helpful and wish you much success on your journey to financial freedom.

Thanks for reading!

Stay safe!

I wish you much success on your journey to financial freedom.

Thanks for reading!

Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long MMM.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.