Three large-cap stocks, and three value options for investors. It's not often that three such large-cap stocks are attractive options for investors, but right now General Electric (NYSE:GE), Raytheon Technologies (NYSE:RTX), and 3M (NYSE:MMM) all look like a good value for the patient investor. Here's why.
3M is showing signs of underlying progress
In a reversal of fortune, 3M has gone from being a stock priced at a premium but with questionable underlying trends, to a stock priced at a discount but with signs of improvement in progress. A quick look at the following chart shows how 3M's valuation has fallen relative to its peers in the last few years. The chart measures enterprise value (market cap plus net debt), or EV, to earnings before interest, taxation, depreciation, and amortization (EBITDA).
Data by YCharts
In a nutshell, 3M used to be priced at a premium because it had a reputation for investing in order to produce high-quality products with pricing power. As such, 3M was always seen as a company with sector-leading operating margins and excellent free cash flow conversion. However, that star has fallen somewhat in recent years.
Data by YCharts
That said, CEO Mike Roman is changing how the company is run by making restructuring and transformational initiatives. In addition, underperforming businesses such as drug delivery are being sold, and management is rumored to be exploring a sale of the food safety business. Meanwhile, 3M has made $7.7 billion worth of acquisitions in healthcare in order to boost growth.
Image source: Getty Images.
Management appears to be taking concerted action to turn 3M around, and an analysis of the recent results shows a company generating improved pricing even during a recession. That's a sign that 3M is making underlying progress, and given that the stock trades on just 16.3 times expected free cash flow (FCF) in 2020 and comes with a 3.6% dividend yield, it's a good value on a risk/reward basis.
Raytheon Technologies
The case for buying Raytheon Technologies, as with the next company, General Electric, is based on the idea that the commercial aerospace market will make a slow recovery from a deep trough in 2020. In addition, Raytheon already has a strong defense business that will support the commercial aerospace-focused business (Pratt & Whitney aircraft engines and Collins Aerospace components) through a difficult period.
While it's completely understandable if investors feel cautious about the aerospace industry right now, Raytheon's valuation makes it look extremely attractive on a risk/reward basis. As such, the stock is a very good option for those willing to be patient. The defense businesses are expected to generate around $4 billion a year in FCF over the next few years, and based on the current market cap of $86.6 billion the stock trades on 21.6 times its defense FCF alone.
Image source: Getty Images.
It's a valuation that doesn't appear to be pricing a lot in for the future FCF that the commercial aerospace businesses could generate. It may well take a few years for the industry to even get close to 2019 levels of activity (when Pratt & Whitney and Collins Aerospace generated a combined $6.2 billion in operating profit), but the industry will surely make a recovery from here.
Moreover, Raytheon is well-placed in any recovery. According to CEO Greg Hayes, Pratt & Whitney's geared turbofan engine currently has a 55% market share on the Airbus A3320 family, and promises multi-decades of aftermarket revenue to come. Furthermore, Collins Aerospace offers an extensive range of commercial aircraft systems and service, from aero-structures and cargo systems through to cabins, flight decks, and avionics. In other words, if flight hours and departures improve then Raytheon will surely be a beneficiary. Meanwhile, the defense businesses (currently two-thirds of revenue) will support the valuation and generate the cash flow necessary to invest in developing new products.
General Electric
As noted above, GE is a stock to buy for a recovery in aerospace. However, it's also a stock to buy for a certain type of value investor. In this case, it's the value investor who believes that a company should be able to improve profit margins relative to its peers.
In GE's case, the argument is that its power and renewable energy businesses should be able to get to the kind of high-single-digit margins enjoyed by Siemens Gamesa and Vestas (renewable energy) and Siemens Energy (power). Doing so could see both businesses generating a couple of billion in combined FCF in a few years' time.
Meanwhile, the healthcare business is a steady grower capable of $1 billion to $1.5 billion in FCF, and investors can hope that GE Aviation will get back to the kind of $4.4 billion in FCF generated in 2019 at some point in the future. All told, it's not hard to see GE generating $5 billion to $7 billion in FCF in, say, five years' time.
Stocks to buy
The following table summarizes the valuation case for buying all three stocks.
| Company |
Price to Free Cash Flow 2020 Est. |
Price to Free Cash Flow 2021 |
Price to Free Cash Flow 2022 |
|---|---|---|---|
|
3M (NYSE:MMM) |
16.3x |
17.2x |
15.8x |
|
Raytheon Technologies (NYSE:RTX) |
40.3x |
17.6x |
14.1x |
|
GE (NYSE:GE) |
n/a |
61.2x |
19x |
Data source: marketscreener.com, author's estimates.
3M looks like a good value as a turnaround play, and GE and Raytheon will look like a very good value at the end of 2022, not in the least because the aerospace industry should be firmly back in growth mode then. As such, all three stocks look like a good value.
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