3M Company (NYSE:MMM) generates large amounts of free cash flow (FCF) that should bode well for MMM stock this year. In fact, the company said its 2019 free cash flow was $5.4 billion for 2019.
3M’s FCF was up an astounding 10% over the previous year. This is important because FCF cuts through all the GAAP and non-GAAP adjustments that make historical earnings comparisons so difficult these days.
FCF gains show that its cash flows, after all the company’s spending other than for dividends, buybacks, and debt repayment, have increased. It also helps shareholders understand whether the company can afford its dividend.
Moreover, 3M’s FCF represents over 6.1% of its present $88.4 billion market value. This FCF yield ratio is very important since it shows that MMM stock is really cheap.
For example, Johnson & Johnson (NYSE:JNJ), has a $374 billion market value but it produces a large free cash flow amount as well. However, its $19.9 billion in FCF represents just 5.3% of its market value. So, in effect, MMM stock is much cheaper than this larger peer.
3M Stock Benefits From Free Cash Flow Conversion
Moreover, MMM was able to “convert” 118% of its 2019 net income into free cash flow. That is a very high figure for most companies. What this means is that 3M generates real cash flow, not just GAAP earnings.
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On top of that, apparently the Q4 FCF was so high, it represented 186% of net income, as the graphic from 3M shows.
How does that happen? The majority of that “conversion” of net income into higher free cash flow comes from its working capital.
Essentially what it means is that 3M’s receivables were paid by its customers faster than before and 3M extended its payables faster than before. This is a sign of a well-managed company that knows how to produce free cash flow.
The Outlook for MMM Stock
3M indicated in its Q4 press release at the end of January 2020, that it expects a similar level of FCF generation. 3M said it expects its full-year 2020 free cash flow conversion to be in the range of 95 to 105 percent.
To understand that, we have to estimate the level of net income growth. MMM said that it expects earnings per share to between $9.30 to $9.75. Since 3M stock has 575.2 million shares outstanding, that implies that net income will be between $5.35 billion and $5.6 billion.
Therefore, 3M’s FCF is expected to be between $5.1 billion and $5.89 billion. This is a very wide range. Given the impact of the coronavirus outbreak on at least one-quarter of growth, one can assume that FCF growth will be at the low end.
As the market likely already expects this in the present stock price, I believe that the market is fully pricing a bad outcome. Does that mean MMM stock is undervalued? Maybe, but one should keep a clear head on this. 3M is a widely diversified industrial conglomerate that has the ability to generate sufficient cash flow during a potential recession.
Moreover, 3M is also a major producer of face masks, which will be in high demand during the coronavirus outbreak. One of its advantages is the 3M makes the masks in the U.S. So far it has not had any disruptions in production.
What Should Investors Do With MMM Stock?
Melius Research recently came out with a “buy” rating on MMM. They cited demand for 3M’s N95 respirator masks now in short supply. In fact, U.S. health officials say there could be a need for 300 million facemasks in the event of a domestic coronavirus outbreak.
In that case, all bets are off on MMM stock. The company would ramp up production, and this could help offset declines in sales at other parts of 3M.
Right now 3M stock has a generous FCF yield of over 6%. Moreover, the dividend yield is 3.98%. This is the highest dividend yield it has had in the past 10 years on average.
This looks like an opportune time to take advantage of a once in a lifetime sale in the price of such a powerful free cash flow generator.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers get a two-week free trial.
