3M Gets a 4.5 in our Stock Valuation Model

3M Co. (NYSE: MMM)                 10/31/2012                                         Last Price: $87.60

VIEW:  START SELL

Based in St. Paul, Minn., 3M manufactures a diversified array of industrial products. Known especially for popular consumer products such as Scotch Tape and Post-It Notes, the company’s portfolio also offers liquid crystal display films, health-care technology, heavy-duty adhesives, and more than 40 other technology platforms. 3M Company was founded in 1902.

Sector: Conglomerates                                                                                                 Industry: Conglomerates

Highlights: 

3M Company is a technology company operating in a variety of segments. The Industrial and Transportation segment offers tapes, adhesives, specialty materials, components utilized in various manufacturing enterprises, and more. The Health Care segment provides medical and surgical supplies. The Display and Graphics segment offers solutions for electronic display, touch screens. The stock closed yesterday’s trading session at $87.60. In the past year, the stock has hit a 52-week low of $75.49 and 52-week high of $95.46. Technical indicators for the stock are bearish for the short term and the company’s near future outlook is not promising.

GROWTH AND BALANCE SHEET

Earnings growth in the past year has decelerated moderately compared to earnings growth in the past three years. 3M is becoming increasingly global: 64% of 3M’s total revenue comes from outside the United States. The in-line Q3 earnings was overshadowed by Q4 guidance which came in 6% (midpoint) below consensus ($1.37-$1.45 vs $1.50). The total Debt/Equity of 35.50% is rather high but acceptable for the industry and much lower than the average. 3M’s operating margins expanded an impressive 140 bps in the quarter to 22.4%. 3M considers China to have a lot of future potential as it transitions from an export oriented economy to a consumer based economy.

VALUATION

We believe there is limited upside potential to valuation due to economic weakness in Europe and moderating growth trends in emerging markets.  The company expects to experience a 2.5% foreign exchange penalty in the next quarter, noted market conditions are challenging and expects the situation to continue through the end of the year. 3M has a PEG ratio of 1.45, above the industry average. MMM ended its third quarter with $5.0 billion in cash equivalents and current marketable securities. The company operates with $6.4 billion in short and long term debt, for a net debt position of $1.4 billion. The P/E of 14 is attractive and below the industry average. The stock is currently trading below its fair value of $100. The beta of 1.02 implies low volatility of the stock with respect to the S&P 500. The company has transitioned from 6 business groups to 5 business groups in order to more closely support its customers.

RECOMMENDATION for next 6 months: We initiate our coverage with START SELL. The company has demonstrated a pattern of bearish technical signs, the earnings performance and weak outlook offers a negative feeling. Shares are up 7.18% year to date as of the close of trading yesterday.

For trading we suggest:

• Buy the January put with a strike of 82.50 priced at $1.31 per contract
• Sell the December put with a strike of 80 priced at $0.52 per contract
• Net Debit to start: $0.79
• Maximum risk: Net debit

NEWS and CALENDAR

01/23     Earnings Release

Sunday October 25, 2012 – 3M Introduces Touchscreen Stylus to Line of Mobile Accessories

Friday October 26, 2012 – UBS Analysts Lower 2013 Estimates for 3M (MMM)

Thursday October 1, 2012 – 3M to Acquire Ceradyne for $860 Million in Cash (MMM)

Monday September 24, 2012 – 3M’s Price Target Boosted at Jefferies & Co., but Estimates Cut on Volume Weakness (MMM)

MMM Strengths

• Brand recognition
• Diversified Revenue streams
• International diversification

MMM Weakness

• Not as Dynamic as Smaller Competitors
• Foreign Currency Exposure
• Conglomerate Structure

Stock valuation model

The model rates stocks from 1 to 10, with 10 being the best using a system of advanced mathematics to determine a stock’s expected risk and return. I am using different fundamental and technical factors in order to rank a stock.

Intrinsic value of the stock

Investors should buy stocks selling at a discount to their intrinsic value, and then patiently wait for the fair value of their investments to be realized.

MMM’s intrinsic value is $100.00 the current price is $87.60, the stock trades 14% below its fair value.

Financials

The financial health of the company the higher the better, we evaluate all the financial ratios of the company.

Sentiment

Investor’s sentiment for the stock

Analyst ratings

The model assigns a value according to analyst’s recommendation for the stock.

Earnings Consistency

We are searching for EPS numbers that are better than the previous year’s. One dip is allowed, but the following year’s earnings should be higher than the previous year. MMM’s annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 5.60, 4.89, 4.52, 5.63, 5.96, this type of earnings action is not favorable as there are two dips in the row.

Total Debt/Equity

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20% or should be less than the average Debt/Equity for its industry

MMM’s Total Debt/Equity of 35.05% is acceptable as the industry average is 164%

EPS This Quarter VS Same Quarter Last Year

The EPS growth for this quarter relative to the same quarter a year earlier is above the minimum 15% that this model likes to see for a “good” growth company. Stocks with improving earnings are worthy of your extra attention.

MMM’s EPS growth for this quarter relative to the same quarter a year earlier is -8.55% below our target.

Annual Earnings Growth

This stock valuation model looks for annual earnings growth above 12%, but prefers higher than 20%.

MMM annual earnings growth rate over the past five years is 3.32%, below our target growth rate.

Current Price Level

Traders should keep an eye open for stocks that are trading within 10% of their 52-week highs, as it is likely to continue in its upward trend.

MMM’s 52 week high is $95.46 current price is $87.60, is 9% below the 52 week high.

P/E Ratio

The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be “moderate”, which in this model states is not greater than 15. Stocks with moderate P/Es are more defensive by nature.

The company has a P/E ratio of 14.00 the average industry P/E ratio is 16.13 and is also below the S&P 500 P/E ratio of 16.30

Insider Ownership

When there is strong insider ownership which I define as 12% or more, management is more likely to act in the best interest of the company, as their interests are right in line with that of the shareholders.

Insiders own 0.05% of MMM stock. Management’s representation is not large enough. This does not satisfy the minimum requirement; companies that pass this test are more attractive to our valuation model.

Technical Analysis

The model is using several technical indicators (MACD, RSI, MFI, OBV, position Indicators) to forecast the trend of the stock for 6 and 12 months, and assign a value.

Our overall technical analysis view is bearish for the stock.