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3M Company (MMM) is a popular value stock given its strong free cash flow and cheap valuation. Moreover, investors shorting out-of-the-money MMM puts are making good income with high yields.
MMM is at $135.09 in midday trading on Monday, Oct. 7. It has risen consistently since its July 26 Q2 earnings release. The company produced strong free cash flow (FCF) results. As a result, MMM stock has a cheap valuation.
For example, in the last 12 months (LTM), 3M generated $5.684 billion in operating cash flow (OCF) and $4.277 billion in FCF after deducting $1.407 in capex spending. That can be seen in Seeking Alpha's LTM cash flow data page.
Cheap Valuation
As a result, given MMM stock's $74.179 billion market value, its LTM FCF yield is very high at 5.77% (i.e., $4.277b LTM FCF/$74.2 billion market cap). That is a very cheap valuation. Assuming its FCF margins stay high, the stock could be worth considerably more.
I discussed this in my Aug. 23 article, “3M Stock Is Still Cheap Here - Short Out-of-the-Money MMM Put Options.” I showed how MMM could be worth $175.68 per share, assuming the company keeps generating 19.9% FCF margins as it did during Q2.
For example, over the next 12 months (NTM) analysts expect to see an average of $24.185 billion in sales ($23.83 billion this year and $24.54 next year). Applying a 19.9% margin against this results in an NTM FCF forecast of $4.81 billion (i.e., 0.199 x $24.185 billion). That is 12.5% higher than the LTM figure of $4.277 billion.
As a result, assuming the market eventually values MMM stock with a 5.0% FCF yield, its market cap will rise to $96.3 billion (i.e., $4.81b/0.05). That market cap forecast is 29.8% higher than today's $74.179 billion.
In other words, MMM stock is worth almost 30% more than its price today of $135.09, or $175.35 per share. That also correlates to what analysts think. For example, the AnaChart survey of 16 sell-side analysts is $161.28 per share.
Shorting OTM Puts
Put options premiums are relatively high now. That provides a good income opportunity for short-sellers of out-of-the-money (OTM) puts. It also gives the short seller an attractive buy-in price should MMM stock fall.
For example, look at the Nov. 1, 2024, options expiration period, a little over 3 weeks away. Put options at the $128 strike price, 5% below today's price, have a good premium of $2.58 per contract.
That provides an immediate yield of over 2% (i.e., $2.58/$128.00 = 2.0156%). That is a very good yield, equivalent to an annualized rate of almost 30% (i.e., 365/25 x 2.0156% = 29.4%). (That assumes the same yield could be achieved every 25 days for a year).
Moreover, this play provides a good buy-in price if the stock falls. For example, the breakeven price after the premium income received is $128 - $2.58, or $125.42. That is $10 below today's and provides downside protection of 7.23%.
I discussed shorting OTM MMM put options in my last two Barchart articles on Aug. 23 and July 29 since the company's Q2 earnings release. In each case the options expired worthless and the investors who followed this advice could have made 1.1% over 3 weeks and 1.27% respectively. So, this can now be repeated for another 2.0%.
In other words, the total expected return shorting put options in the last 9 weeks has been 4.37%. If the investor also held MMM shares long, they could have made another $10 or so, since I started discussing shorting puts when MMM was at $125.60. That is another 7.6% in unrealized gains.
The bottom line here is that MMM stock still looks cheap given its strong FCF. Holding the stock long and shorting OTM puts is one way to play this for value investors who want exposure to the company's upside potential.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
