Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: 3M Company – Fourth Quarter of 2020 Earnings IR Presentation

By Callum Turcan

In alphabetical order by ticker: MMM, RTX, VZ

The coronavirus (‘COVID-19’) pandemic generated substantial headwinds for the global economy in 2020 and for most businesses large and small, save for many firms operating in the IT sector. However, several large industrial and telecommunications companies are reporting that the outlook for 2021 looks quite bright, relatively speaking, as ongoing vaccine distribution efforts indicate the pandemic will be brought to an end sooner than expected.

3M (MMM) -- Dividend Yield: ~3.3%

The industrial conglomerate 3M Company (MMM) beat both consensus top- and bottom-line estimates when it reported fourth quarter earnings for 2020 on January 26. 3M has a meaningful personal protective equipment (‘PPE’) business and has raced to keep up with elevated demand due to the COVID-19 pandemic, though demand for some of its other offerings have faced meaningful headwinds of late.

From 2019 to 2020, 3M’s GAAP revenues were broadly flat as growth at its ‘Safety and Industrial,’ ‘Health Care’ and ‘Consumer’ business operating segments offset the steep decline seen at its ‘Transportation and Electronics’ segment. When excluding divestment gains from its operating income, 3M’s non-GAAP adjusted operating income rose by 11% year-over-year in 2020 due to gross margin expansion (enabled in part via economies of scale due to its strong organic sales growth) and moderate reductions in its operating expenses.

Looking ahead, 3M aims to grow its total sales by 5%-8% annually in 2021, with annual organic currency-neutral growth forecasted at 3%-6%. The firm expects its EPS will come in between $9.20-$9.75 this year, a meaningful increase from its adjusted non-GAAP EPS of $8.74 in 2020 (3M posted $9.25 in diluted EPS on a GAAP basis in 2020).

In a supplement financial information segment included in its earnings press release, the company noted it generated $6.7 billion in “adjusted” free cash flow in 2020. 3M spent $3.4 billion covering its dividend obligations and $0.4 billion buying back its stock in 2020, both activities of which were fully covered by its adjusted free cash flows. Management aims for the firm to post a free cash flow conversion rate of 95%-105% this year as the company forecasts it will generate $5.1-$6.0 billion in free cash flow in 2021. We caution that 3M exited 2020 with a net debt load of $13.8 billion (inclusive of current marketable securities and short-term debt).

As of this writing, shares of 3M yield a nice ~3.3% and are trading around our fair value estimate of $175 per share. The company’s Dividend Cushion ratio is near parity (~1), earning 3M a “GOOD” Dividend Safety rating. We factored in strong forecasted dividend growth over the coming years into 3M’s Dividend Cushion and Dividend Safety metrics, as 3M earns an “EXCELLENT” Dividend Growth rating. We're big fans of 3M’s free cash flow generating abilities which should enable the firm to stay on top of both its net debt load and dividend obligations going forward.

Raytheon Technologies (RTX) -- Dividend Yield: ~2.8%

Aerospace and defense giant Raytheon Technologies Inc (RTX) also beat both consensus top- and bottom-line estimates when it reported fourth quarter earnings for 2020 on January 26. The COVID-19 pandemic weighed negatively on its performance last year, though management expects things are beginning to turn around now. In 2021, Raytheon Technologies forecasts it will post $63.3-$65.4 billion in sales and $3.40-$3.70 in adjusted non-GAAP EPS, compared to the $56.6 billion in GAAP revenues and $2.73 in adjusted non-GAAP EPS the firm generated in 2020. Additionally, the company aims to generate $4.5 billion in free cash flow and plans to spend at least $1.5 billion buying back its stock this year.

Raytheon Technologies exited 2020 with a large net debt load of $23.0 billion (inclusive of short-term debt) which will make navigating the potential rebound in commercial aircraft production a more difficult task. The firm’s ‘Pratt & Whitney’ business operating segment produces jet engines, helicopter engines and auxiliary power units for both civilian and military aerospace purposes. In 2020, this segment saw its sales and adjusted operating profit tank as demand from civilian customers for its aerospace-related services and spare parts fell off a cliff, though the segment’s military sales offered a bit of a reprieve. A similar story played out at Raytheon Technologies’ ‘Collins Aerospace’ business operating segment which is an aerospace supplier to both civil and military customers (offerings include cabin seating, lighting, and engineering solutions, oxygen systems, water and waste management systems, among various other offerings).

The company’s ‘Raytheon Intelligence & Space’ and ‘Raytheon Missiles & Defense’ business operating segments performed quite well, relatively speaking, as domestic defense spending remained robust last year. We expect domestic defense spending will continue to be robust going forward, and additionally, the outlook for defense spending levels globally is supported by rising geopolitical tensions. As Raytheon Technologies’ civil-facing businesses recover while its defense-facing businesses continue to perform well, its financial performance should post a significant rebound this year assuming global health authorities are eventually able to bring the COVID-19 pandemic under control now that vaccine distribution activities are underway.

Shares of RTX yield ~2.8% as of this writing. Raytheon Technologies has a Dividend Cushion ratio of 1.9, earning the firm a “GOOD” Dividend Safety rating, and please note these metrics incorporate our assumptions that the firm’s dividend will grow at a moderate pace going forward. We give the company a “GOOD” Dividend Growth rating. As of this writing, shares of RTX are trading in the lower bound of our fair value estimate range, indicating shares are fairly valued when considering the headwinds its commercial aerospace operations are currently facing.

Verizon Communications (VZ) -- Dividend Yield: ~4.4%

Telecommunications giant Verizon Communications Inc (VZ) also beat consensus top- and bottom-line estimates when it reported fourth quarter earnings on January 26. In the fourth quarter, Verizon noted its wireless business had 703,000 retail postpaid net additions with growth coming from both its consumer-facing and business-facing segments. Additionally, Verizon’s Fios internet provider business had 92,000 net additions in the fourth quarter.

For all of 2020, Verizon’s GAAP revenues declined by 3% and its GAAP operating income dropped by 5% year-over-year. Verizon’s revenues were held down by a sharp drop in its ‘wireless equipment revenues’ though its ‘service revenues and other’ was broadly flat. Reductions in its operating expenses were not enough to offset reduced economies of scale and incremental costs relating to the COVID-19 pandemic.

Looking ahead, Verizon expects its financial performance will rebound this year, supported by the adoption of 5G wireless technologies. Management forecasts Verizon will post “service and other revenue growth of at least 2 percent, including total wireless service revenue growth of at least 3 percent” in 2021, along with $5.00-$5.15 in adjusted non-GAAP EPS. For reference, Verizon posted $4.90 in adjusted non-GAAP EPS in 2020.

In 2020, Verizon remained a free cash flow machine, generating ~$21.6 billion in free cash flow (including ‘acquisitions of wireless licenses’ within the capital expenditure calculation) while spending $10.2 billion covering its dividend obligations (Verizon did not appear to spend a significant amount buying back its stock during this period). This year, Verizon expects to spend $17.5-$18.5 billion on capital expenditures as it continues to bulk up its 5G wireless infrastructure in the US.

At the end of 2020, Verizon had a net debt load of $106.9 billion (inclusive of short-term debt) which weighs negatively on its forward-looking dividend coverage, though the firm’s strong cash flow profile makes that burden manageable for now when including its ability to tap capital markets at attractive rates. Verizon has a Dividend Cushion ratio of 0, earning the firm “VERY POOR” Dividend Safety and Dividend Growth ratings (note that the Dividend Cushion ratio is a dividend health ranking tool much like a corporate credit rating). Shares of VZ yield ~4.4% as of this writing and are trading in the lower bound of our fair value estimate range, indicating the firm is fairly valued at this time.

Concluding Thoughts

As we head into 2021, many firms (particularly those outside of the IT sector) expect their financial performance will improve significantly going forward after a challenging 2020. We remain optimistic that global health authorities will eventually be able to bring the COVID-19 pandemic under control, aided by vaccine distribution efforts, which underpin our expectations that the world economy will be able to recover and then expand going forward. Our fair value estimate on S&P 500 stands at 3,530-3,920.

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Related: MMM, RTX, VZ

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Callum Turcan does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.