Formerly known as Minnesota Mining and Manufacturing, industrial icon 3M (NYSE:MMM) has lost roughly a third of its value over the past three years. The stock is only down about 7% or so in 2020, so there’s more to that decline than the 2020 COVID-19 pandemic.
Trading near a three-year low, is 3M worth buying today? Here’s what you need to know to decide.
How cheap is it?
Valuation can be kind of tricky at times, particularly for economically sensitive companies like industrials. Indeed, a company like 3M will see earnings decline during a recession (like the one that started in February), but its long-term earnings power will largely remain intact. The problem is that demand has simply fallen off during the downturn. So the price-to-earnings ratio may not be the best gauge of valuation for 3M.
Two alternative ways to look at valuation, however, are the price-to-sales ratio and the relative dividend yield. Sales and dividends tend to be more stable over time, allowing investors to look past the inherent ups and downs of a cyclical company’s earnings. 3M’s price-to-sales ratio today is about 3.1 times, versus a three-year average of 3.6 times. The company’s dividend yield, meanwhile, is in the 3.5% range. The last time the yield was this high was during the 2008-09 Great Recession. You’d have to go back to the mid-1990s to find another time that the yield was this high.
Using these two valuation tools, 3M appears to be trading hands at a price that long-term dividend investors should find attractive. But the interesting thing is that the global pandemic isn’t the driving force of the low price here — the industrial giant’s big price decline started well before COVID-19 made its appearance. So what’s going on?
Every company has its warts
The choice to buy a stock always comes with compromises, since no company is perfect. When you are looking at a stock that appears to be cheap, the trade-off is usually something about the business. For the most part, 3M is performing pretty well given the COVID-19 headwinds it’s facing. For example, it earned $1.78 per share in the second quarter, down roughly 16% year-over-year. More importantly, each of its four main business units maintained double-digit operating margins. Its worst-performing unit was healthcare, with a still-impressive 16.8% operating margin. The company isn’t hitting on all cylinders today, but it is hardly struggling to get by.
That said, 3M’s financial debt-to-equity ratio is roughly 0.25 times. On an absolute basis that’s fairly modest. However, it’s near the highest levels in the company’s history. So while it would be hard to suggest that debt is a huge problem, it is an issue that investors need to watch more closely today than ever before. The dividend payout ratio, at around 65%, is also toward the high end of the company’s historical range. It’s not an outlandish number, but again it is something that bears watching.
On their own, those two issues would be things to monitor, but not factors that would drive droves of investors away from 3M. But that brings up the bigger issue here: a pair of material lawsuits. One is tied to environmental issues related to manufacturing plants, and the other is tied to product safety. These are long-running issues that will take time to resolve and may end up costing 3M a lot of money. This is the reason why 3M’s stock has fallen so hard over the past three years.
That said, 3M is a roughly $100 billion market cap company with an investment-grade credit rating. And while leverage is historically high, given the company’s size and industry position it can probably handle the legal hit without too much difficulty. In other words, 3M’s legal troubles are a very real issue, but not one that’s likely to be insurmountable. More to the point, it looks like investors have priced in the risk at this point.
On sale and worth the price
All in all, it looks like Mr. Market has put 3M on the sale rack. There are very legitimate reasons for that decision, but it’s likely that the company will be able to handle the legal headwinds it’s facing. If you can stomach a little uncertainty, the stock is probably worth looking at while it’s still cheap.