Big-Moat, Low-Growth 3M Stock Is Stuck in Neutral
Amid a flurry of other earnings report, industrial giant 3M (NYSE:MMM) reported pretty good second-quarter numbers that topped expectations on the top and bottom line.
Yet, 3M stock opened up in the red after those numbers. It has since rebounded. But, as of this writing, 3M stock is up only about 1% after reporting a solid, double-beat quarter.
Why is that? Some will blame the guidance cut. Management lowered the top-end of this year’s expected earnings from $10.55 to $10.45. But the dime cut in full-year earnings isn’t material. And it’s mostly due to a one-timer from a business divestiture.
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Therefore, I don’t think it is reasonable to blame 3M stock’s rather bland post-earnings reaction to the guidance cut.
Instead, I think the root of the problem is that between $190 and $210, 3M stock is hovering in fairly valued to slightly overvalued territory. And growth isn’t showing up in any big way to warrant a higher price tag for 3M stock. As a result, the stock is just somewhat stuck in neutral.
Here’s a deeper look.
3M Is a Great Company With Low Growth Prospects
3M is a great company with its fingers touching everything that matters.
From safety to healthcare to electronics and energy, 3M is providing original equipment manufacturer (OEM) platforms and components for a bunch of secular growth industries — think automated driving, connected roadways, biomedical technology, data centers and so on. Considering the complexity inherent to manufacturing these components, 3M has also constructed massive moats in these secular growth industries. Thus, 3M has essentially guaranteed itself steady revenue growth potential over the next several years as global investment in things like automated driving, biomedical technology and data centers picks up.
In other words, so long as the global macroeconomic backdrop remains healthy, 3M will report solid numbers.
We saw this last quarter. Organic local-currency sales growth was 5.6%, versus 2.2% last quarter and 5.2% last year. Growth was broad-based across all geographies and operating segments, with growth in each segment ranging from 4% to 9%.
These growth rates are here to stay. Global economic growth prospects remain strong. But, 3M’s growth rates aren’t set to go higher. Global real GDP growth is set to decelerate to a run-rate of roughly 3% over the next several years, versus 3.1% in 2017. Thus, global growth prospects aren’t improving. Instead, they are stabilizing.
Going forward, then, this is a company with 5% revenue growth potential over the next 5 years. That revenue growth is protected by a wide moat, but it doesn’t have many catalysts on the horizon which could spark 10%-plus growth. Thus, this is a big-moat, low-growth company.
3M Stock Isn’t Worth Much More Than $200
Unfortunately, big moat, low growth won’t spur big gains for 3M stock from $200.
Margins are on a multi-year uptrend. That should continue as the company faces very little competition at scale and, thus, guarantees itself healthy pricing power. Therefore, operating margins should be able to trend towards 27.5% over the next five years, versus under 25% last year.
But even if 3M does grow revenues by 5% per year and gets margins to 27.5% in five years, I still don’t think 3M stock has big growth prospects ahead of it. Those assumptions lead to me to believe that 3M can do about $14.80 in earnings per share in 5 years.
A historically-average 19 forward multiple on that implies a four-year forward price target of $280. Discounted back by 10% per year, that equates to a year-end price target of roughly $210 for 3M stock. This implies ~5% upside into the end of the year.
That is good, but not great, return. Consequently, I think investors can do better elsewhere.
Bottom Line on 3M Stock
3M stock’s big moat, steady growth prospects and healthy 2.5% dividend yield are reasons to own this stock for risk-adverse investors.
But for growth-oriented investors seeking alpha, 3M stock isn’t all that interesting at $200. I realistically see 5% upside into the end of the year, but further gains will be tough to come by.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
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