3 actions to help you join the $ 100 billion club


It’s not often when you can really describe three of the industry’s hottest stocks as “unloved” or “ignored,” but it does right now. In a nutshell, there seems to have been a leak to quality in the industry and that has left some of the less sought after names like General Electric (NYSE: GE), Raytheon Technologies (NYSE: RTX), and 3M (NYSE: MMM) undervalued in relation to their growth prospects.

Coincidentally, the shares of all three companies are currently trading on an individual market cap of around $ 100 billion. Here is why they are good value for investors.

It’s the free cash flow that counts

What binds the three companies together is their future free movement of capital (FCF). Simply put, this is the year’s cash flow that a business has left in profits after removing working capital and capital expenditures.

Image source: Getty Images.

In a nutshell, it is the “free money” a company has to do all the things that improve shareholder value, like repurchasing shares, paying dividends, investing in acquisitions. or debt repayment. As a guide, a price / FCF multiple of around 20 is considered fair value for an industrial conglomerate whose revenues are increasing in line with the economy.

The reasons all three are good investments are based on their FCF ratings.

1. 3M

The company generates a lot of cash and is currently trading at a significant valuation multiple relative to its peers. The graph below compares 3M to its closest counterpart, Illinois Tool Works (NYSE: ITW). Both are multisectoral conglomerates with high exposure to the automotive industry. To be fair ITW is a great company and I am the first person Argue that it deserves to trade at a premium at 3M.

In addition, 3M has potential liability in litigation relating to PFAS, a group of chemicals the company has produced that are considered hazardous. In addition, 3M’s execution and advisory provision – particularly in the healthcare segment – has left a lot to be desired in recent years.

However, the question is, what premium does ITW deserve and how much should 3M’s performance be reduced?

MMM price chart to free cash flow

Data by YCharts

Let’s put it this way. If 3M traded at a 10% discount on ITW and we used a price / FCF multiple of 21.9, then based on this year’s adjusted FCF ($ 6.7 billion), 3M’s market cap would be $ 147 billion. That’s a figure of nearly $ 46 billion above its current market cap. Alternatively, using a multiple of 20 suggests 3M is undervalued by $ 34 billion.

Frankly, those are huge numbers to take for PFA liability and a valuation haircut, especially since CEO Mike Roman is actively company restructuring and reshaping the healthcare segment. Add a well-hedged dividend (current yield of 3.4%) and 3M’s stock appears to be good value.

2. General electric

It’s no secret that the commercial aviation market has been hit hard by the COVID-19 pandemic, and most observers don’t expect it to return to 2019 levels until 2023 Knowing this, there are two ways of looking at it. The first is to be wary of lost revenue / FCF and the uncertain timing of recovery – something that largely depends on containing the pandemic. The second is to view it as a multi-year growth opportunity for companies like GE and Raytheon Technologies, as they will be starting from scratch in 2020.

An aircraft engine undergoing maintenance.

Image source: Getty Images.

The investment case for GE is based on a combination of a takeover at GE Aviation, continued and strong FCF production at GE Health Care and a multi-year improvement in profit margin and FCF production at GE Renewable Energy and GE Power.

The proof of the latest results report is that GE is making progress on these goals. Therefore, management has shifted towards FCFs of $ 2.5 billion to $ 4.5 billion in 2021.

The midpoint of the range would place GE on a price / FCF multiple of around 27 times 2021 FCF. Although this sounds expensive, readers should note that GE is configured for a multi-year recovery in FCF and it is only in 2023 at the earliest that GE Aviation can expect to regain the kind of 4.4 billion dollars of FCF generated in 2019 against zero in 2020.

3. Raytheon Technologies

A similar argument applies to GE’s aviation rival, Raytheon Technologies. Both compete with engines on the Airbus A320neo family of aircraft. In addition, within commercial aviation, Collins Aerospace of Raytheon also manufactures aerostructures, avionics, mechanical systems, power systems and even cabins.

A missile being launched.

Image source: Getty Images.

Raytheon will take time to recover, but in the meantime it will receive strong support from its defense activity (missiles, defense systems, radars, intelligence systems and space solutions, including satellites). In fact, defense now accounts for around two-thirds of the company’s total revenue.

Management plans a strong recovery in commercial aviation profitability from the second quarter and is targeting $ 5 billion adjusted FCF for 2021. This is a figure that would put Raytheon on a 20-fold price / FCF multiple predicted for 2021 FCF. This is great value for money for a company moving towards a continued takeover of FCF from commercial aviation. Add a 2.9% dividend yield and Raytheon is an attractive stock by any means.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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