3M (NYSE:MMM) has been in a transitional phase for many quarters. The consequences are stagnating revenues and slightly declining margins. While share buybacks have artificially bloated earnings per share, it was primarily the dividend that kept many investors in line. I still believe that it will take many more quarters or even years before 3M returns to sustainable growth. But this does not mean that the shares are a terrible investment. 3M certainly offers investors “value”. Currently, they can also get this value at a fair price. Thus, 3M is not a bargain, but at the moment, it is okay to buy a broadly diversified company with an excellent track record at a fair price. That’s why the company is high on my list of additional purchases.

Note: If you want to save the next dividend, you should make sure to have shares in the portfolio on Thursday. That’s when 3M goes ex-dividend.

Investors need patience

This year should end unspectacularly for 3M investors. They will probably not have achieved significant price gains in total (excluding dividends). Of course, one could say that in a year like this and the economic distortions caused by the corona crisis, this is a success. But with such a statement, we would be lying to ourselves because the fact is that competitors of 3M would have been the better choice. Especially Honeywell (NYSE:HON) and Corning (NYSE:GLW) performed much better.

ChartData by YCharts

Operationally, 3M did not do so poorly compared to Honeywell and Corning (regarding quarterly YoY growth).

ChartData by YCharts

A glance at the estimates also makes 3M look better than the share price development would suggest. Although the company will remain below Honeywell’s growth rate, there should be no valuation discount compared to Corning.

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ChartData by YCharts

However, if we look at the P/E ratio, it is noticeable that 3M is trading at a relatively large discount on the market. 3M has a PE ratio of 19.91 and a forward PE ratio of 19.77, while its competitors’ forward multiples are above 25. Investors have had to be patient over the last few years and are now faced with a company that has a more considerable discount than its competitors. And it looks like they will continue to need patience. As I described before, 3M has been suffering from the weakening economy for some time pre-COVID-19 and was also busy investing in further growth and streamlining the business from five business groups to four. The company will have to deal with this mission for a while yet since October growth also was only in line with previous growth rates on a year-to-year basis:

Total sales for October increased 3 percent year-on-year to $2.9 billion. Organic local-currency sales (which includes organic volume impacts and selling price changes) increased 2 percent, and acquisitions, net of divestitures, added 1 percent while foreign currency translation was flat year-on-year.

Total sales increased 12 percent in Health Care, 7 percent in Consumer, and 4 percent in Safety and Industrial, while Transportation and Electronics declined 4 percent. Organic local-currency sales increased 8 percent in both Health Care and Consumer, and 4 percent in Safety and Industrial, while Transportation and Electronics declined 4 percent.

Thus, 3M is more or less in line with the last pre-COVID-19 quarter.

(Source: 3M 1Q 2020 results)

Patience can pay off

This limbo phase of low or flat growth is unfortunate, but there are good reasons to remain patient. Companies go through cycles, which applies both to their business performance and the development of their share prices. At 3M, this process is still ongoing. There are always several years in which business stagnates, growth markets are developed, and new growth machines are generated. Companies like 3M have experience with such transformation processes. 3M itself is a good example. In 1994, the company achieved a turnover of USD15.1 billion. In 2002 the revenue was just USD16.3 billion. Thus, in eight years, the company had grown by only 8 percent, which changed massively in the following years when 3M increased its revenues to USD32.7 billion in 2018.

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Currently, investors have the opportunity to take advantage of such a transitional phase again.

The sweet spot of fair value and a 20 percent upside potential

And investors still get the company at a fair price. All historical fair value multiples currently converge into one sweet node of fair value, offering a 20 percent upside potential for the next two years based on expected earnings/cash flows.

3M is also going ex-dividend this week. Fair value calculation 3M

Fair value calculation of 3M, Source: DividendStocks.Cash

The upside potential is based on the following estimates:

31/12/2020 31/12/2022
EPS USD 9.01 USD 9.97
Adj. EPS USD 8.59 USD 10.16
Operating Cashflow USD 12.16 USD 13.11

The risk you take here is that 3M will not achieve these risks and will take even longer to return to good growth. Even if 3M reaches these earnings and cash flows, there is no guarantee that the share price will rise to a fair value. In the end, you still get a company with a guaranteed dividend yield of 3.5 percent at a reasonable price. The downside potential is, therefore, relatively limited. The balance sheet is also nothing to worry about. The substantial share buybacks have resulted in 3M sitting on treasury stocks worth almost USD30 billion. This means that 3M can easily buy Corning, which has a slightly above USD27 billion market capitalization. Although this is not a likely scenario, it does indicate the capital strength of 3M.

Balance sheet. Source: DividendStocks.Cash


3M has given little pleasure this year. But investors should still show patience. They are currently getting the company at a fair price, which will most likely run into an undervaluation in the next few years, opening up an upside potential of 20 percent. Therefore, the downside scenario is limited, which is why I will probably increase my stake in the coming weeks. Then, I will let the shares slumber in my portfolio for the next 10, 20 years.

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3M is part of my diversified retirement portfolio. If you enjoyed this article and wish to receive other long-term investment proposals or updates on my latest portfolio research, click “Follow” next to my name at the top of this article, and check “Get email alerts”.

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.