3M Shares Still Have Value, Even if They Are Expensive

NEW YORK (TheStreet) -- 3M (MMM)   shares aren't cheap. You can tell that by how the stock has moved sideways since hitting an all-time high in June. But 3M does have value -- investors just have to know where to look.

The stock, at close to $144,  is about where it was on June 6. Shares are up just 2.6% on the year to date, trailing the 3.3% gain of the Dow Jones Industrial Average.

At a price-to-earnings ratio of 20, I can see why Wall Street is hesitant to pounce on 3M, the conglomerate best known for its tape products. That's one full point lower than Johnson & Johnson (JNJ) and almost two points lower than another conglomerate like Honeywell (HON) .

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But 3M is trading at that valuation for a reason. The company consistently delivers where it matters -- on the bottom line. Very seldom do good companies get cheap, especially one that has an gross margin that is 17 points higher than the industry average (48% vs. 31%), according to Yahoo! Finance. By contrast, Honeywell trails the industry gross margin by three points.

What's more, not only is 3M outperforming General Electric (GE) in revenue growth, 3M almost doubles GE in operating margins (22% vs. 12%). Yet, GE enjoys a P/E that is one point higher. In other words, "expensive" doesn't always mean what it implies. In the case of 3M, the market has gotten this story wrong.

This is a company that is operating an efficient business. Thanks to diligent cost controls, management is building the sort of operating leverage needed to grow both net earnings and earnings per share. In the most recent quarter, these grew by 6% and roughly 12%, respectively. Very few companies -- and none that are cheap -- are able to deliver that sort of return.

The other thing is, investors sometime forget that 3M is more than just Post-it notes. 3M is also a well-respected name in areas like health care, electronics, energy and safety, among others.

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In fact, the company just announced that its subsidiary, 3M New Ventures has taken an equity stake in Smart Energy Instruments, a Canadian company that develops electronic chipsets for smart grids. This is an industry that is projected to grow $50 billion by 2023.

A 3M representative was not available for comment. So I can only speculate that as Smart Energy's capabilities grow, so will 3M's investment. Management will then have to decide if it wants to remain just minority stakeholders. I don't expect that to be the case.

To the extent that 3M is able to leverage Smart Energy's expertise in this sector, 3M just might have secured its next leg of growth for the next decade. Just think, in the next couple of years 3M may emerge as one of the most dominant names in renewable energy. Iit's only costing the company today an estimated $5 million in total financing.

The way I see it, it's a mistake to judge 3M today on its perceived slow-growth trajectory, especially when management is projecting 9% to 11% growth in earnings per share and 20% return on invested capital in the next three years. That's strong return for a company that's already producing high-single-digit growth in free-cash flow.

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All told, the stock -- expensive as it may be -- is trading on the all of the qualities you would want from a respected brand. With the company having just boosted the dividend by 35%, there is still plenty of value and growth ahead for investors to realize.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

TheStreet Ratings team rates 3M CO as a Buy with a ratings score of A+. TheStreet Ratings Team has this to say about their recommendation:

"We rate 3M CO (MMM) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, notable return on equity, expanding profit margins and solid stock price performance. We feel these strengths outweigh the fact that the company shows weak operating cash flow."

You can view the full analysis from the report here: MMM Ratings Report

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