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After all, in a “flight to quality”, 3M shares seem to be an attractive target. The company is one of the major American industrial companies. with a return of close to 4%. Valuation on an earnings basis looks reasonable, if not attractive.
To be fair, it is possible that 3M over time will prove to be a solid long-term investment. It has been so in the past that a “dividend aristocrat” with 62 years in a row of dividends is increasing.
But as I was in August, I am skeptical even of the long-term case, because I see significant risks ahead. In the short term, the MMM stock does not look like a “buy dip” candidate. The fear that coronavirus from China is pushing global equities is a problem for almost all equities on the market, but they pose a special risk to 3M equities.
The core case for 3M right now is that it is a wonderful company that is simply going through short-term problems. Uprising in China and the car industry, in particular, pushed the results for 2019.
But these questions will pass. Meanwhile, MMM shares have historically been a solid investment. The total return over the past 25 years, according to YCharts, is just a hair shy of 1000%. That is almost exactly a 10% compound annual return – an excellent figure over such a long distance.
However, there is an important reason for caution: we have heard that case before and not so long ago. Another American industrial giant with a history of dividend increases struggled, and many investors seemed to benefit from the downturn. As one author wrote in 2017:
[This company] requires patience, simple and easy. Investors must be willing to give the industrial conglomerate the time it takes to get out of business … but if they do, [the] stocks will pay off.
As another put it earlier that year:
The 16 analysts who offer 12-month price forecasts …[suggest] an increase (ie reinforcement) of approximately 17% to 18% … When its share is adjusted after the income statement has been received, taking into account its dividend, investors can gain more than 20% in terms of total return.
Although it is impossible to predict how this year will work [the company], for those who recognize the ability of this proven company to cut success, the stock is a great choice.
Value Trap or Value Play?
That company was, of course, General Electric (NYSE: GE). The GE stock would start 2017 above $ 30 and close the year below $ 17. In December 2018, the stocks tested lower financial crisis period levels below $ 7.
These quotes are not intended to elicit the specific authors. Like virtually all other investors, I have also tried to time the bottom too early or owned stocks that were value traps instead of value games. I even saw some value in the GE share at the end of 2017 myself.
Rather, the point is that the “simple” argument for MMM stocks here is not enough. A success story does not guarantee a continuation of that success in the future. GE shows it. IBM (NYSE: IBM) shows it. So does Kraft Heinz (NASDAQ: KHC).
To be safe, this does not mean that MMM shares will lose 75% of their value, as will GE. But there are some similarities with the stories. JP Morgan Chase analyst Stephen Tusa is mostly right in his long-standing bias against the GE share – and Tusa called 3M’s business model “broken” in a note last year.
GE’s earnings began to decline before finally turning around in 2018. 3M’s guidance for adjusted net income in mid-2020 suggests a decline from 2017 levels. That guide does not seem to contain much, if any, impact from the coronavirus fear: CEO Mike Roman said at the time of the fourth-quarter conference call last month that 3M expected a return to China’s sales growth this year. The outlook will almost certainly change after this week’s sharp decline in the Dow Jones Industrial Average.
This is a stock that has gone in the wrong direction since the end of 2017 and fell 40% from its peaks. 3M has at least a lot of work left to do to reverse the declines. A history of dividend increases does not in itself make it easier.
The short-term problem for MMM stocks
Of course, it is just as easy to write off 3M completely. In the long run, there is a case for a turnaround – and a valuation that does not contain much in the way of success on that front.
But it is extremely difficult to make the case to buy MMM shares on this specific dip when global markets are gaining momentum. Again, by the management’s own recognition, two major areas of weakness have been the automotive industry and the Chinese market. Pandemic fear will only exacerbate these problems.
Revenues in China and Hong Kong decreased by 4% in local currency in 2019, according to a 10-K form that the company submitted to the US Securities and Exchange Commission. Right now, it looks like 2020 will be worse – potentially much worse.
Vehicle stocks Ford (NYSE: F) and General Motors (NYSE: GM) both fell more than 4% on Monday. Ford challenges a multi-year low; GM is not far from doing the same. These moves hardly indicate a recovery in that key market.
As a result, 3M is starting to look like a 2021 story early on. And if these end markets outperform, there are better ways to play it. F and GM are much cheaper. China-exposed pieces that Apple (NASDAQ: AAPL) or Starbucks (NASDAQ: SBUX) have sold off. Some Chinese names have fallen longer.
In fact, the entire market is cheaper after Monday’s trading. In fact, each of the 30 Dow Jones Industrial Average components decreased. Unbelievably, the decline of 2.8% in the MMM stock was actually in the upper half of the index.
There is no shortage of “buy dip” opportunities out there right now. It is difficult to make the case that 3M shares are one of the most attractive. There are real problems here, which are likely to get worse by 2020. At least there is no need to hurry.
At the time of writing, Vince Martin has no positions in any of the securities mentioned.