We think that 3M stock (NYSE: MMM) currently is a better pick compared to Emerson Electric (NYSE: EMR), despite Emerson’s revenue growing at a faster pace over the recent years, and it trading at a more expensive valuation compared to MMM stock. While both the stocks trade at about 3x trailing revenues, if we were to look at other valuation metrics, EMR stock appears to be more expensively priced with 21x P/EBIT ratio and around 25x P/E ratio, compared to 14x and 17x for MMM stock, respectively.
Although both the companies saw a rise in revenue over the recent quarters, led by the economic recovery, the growth has been better for MMM, aided by high demand for personal protective equipment during the pandemic. However, there is more to the comparison. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical revenue and operating margin growth. Our dashboard 3M vs Emerson: Industry Peers; Which Stock Is A Better Bet? has more details on this. Parts of the analysis are summarized below.
1. Emerson’s Revenue Growth Has Been Stronger
Now, 3M’s revenue growth over the last twelve months period was stronger than Emerson (11% vs. 4%), given a high demand for safety and personal protective equipment. However, if we were to look at the three-year average revenue growth, Emerson’s CAGR of 3.2% is higher than just 0.6% for 3M. Emerson’s sales over the recent years have been better given the steady demand for residential, cold-chain, and professional tools. For 3M, the revenue growth was impacted during the pandemic due to several offices being shut, given the lockdowns and shelter-in-place restrictions, resulting in lower demand for office products. Similarly, the demand for transportation products was also down due to lower production of cars. This decline was offset by higher demand for its health care products, including masks. Our dashboard on 3M’s revenues offers more details on the company’s segments.
Looking forward, 3M’s revenues are expected to grow in low double-digits in 2021, but the growth rate will likely slow to mid-single digits next year. For Emerson, revenues are expected to grow in mid-single-digits in 2021 as well as 2022, going by the consensus estimates. Both the companies will benefit from economies opening up. Emerson Electric is expected to see steady revenue growth with continued demand for its process automation offerings, which are crucial for manufacturing companies to cut manpower costs and boost margins, and, Emerson, being a leader in this space, should stand to benefit meaningfully as the global economy recovers. 3M will see a rise in demand for office products and continued uptick in safety materials sales. However, overall automotive production is facing headwinds due to chip shortages, a trend likely to continue in the near term and weigh on 3M’s automotive business, as well.
2. 3M Is More Profitable
3M’s operating margin of 22% over the last twelve month period is better than 16% for Emerson. Even if we were to look at the last three-year average operating margin, 3M’s 21% figure tops 15% for Emerson. 3M’s operating margin of 22% over the last twelve month period compares with 19.2% in 2019, before the pandemic. The current operating margin of 16% for Emerson is lower compared to 3M, and it compares with the 15% figure in 2019. We expect margins for both companies to face some headwinds going forward, given the inflationary pressure and supply chain disruptions.
The Net of It All
Now that over half of the U.S. population is fully vaccinated against Covid-19, with overall economic activity picking up, both the companies are expected to see steady revenue growth going forward. Now, 3M’s current valuation is surely more attractive than that of Emerson, and it is also more profitable. However, if we were to look at financial risk, Emerson has a better debt and cash position, with its debt as percentage of equity of 13% vs. 15% for 3M, and cash as percentage of assets of 12%, compared to 10% for 3M, implying that MMM stock has higher financial risk, compared to EMR stock. That said, we believe that 3M is a better pick among the two stocks, with slightly higher risk, but better profitability and lower valuation.
While MMM stock may see higher levels, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Corning vs. LGI Homes.
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