3M and Danaher: A Tale of Two Industrials

3M (MMM) has outperformed Danaher (DHR) during the past six months. Does the way investors view how they deploy capital help explain the difference?

Reuters

Nomura’s Shannon O’Callaghan and team don’t think the market gets how much 3M could benefit from better capital deployment:

Back in December, we upgraded 3M with a view that the company could take a more aggressive stance on capital allocation, and that has begun with $1.7B of share repurchase in each of the last two quarters, and an increase in debt. But, after recently spending a couple of days with management, there are several factors we view as underappreciated: 1) the driver of management's plan to add debt is not to boost EPS with buyback (though that is a nice side effect) but rather to lower 3M's cost of capital; 2) this suggests that the buyback won't slow even if organic earnings surprise on the upside; and 3) another use of added debt is expected to be medium and larger acquisitions, which is a capability historically missing at 3M that could further benefit the P/E. We think 3M could be changing from a sleepy mid-single-digit EPS grower to a double-digit EPS grower with drivers of potential upside.

3M has gained 8.3% during the past six month, which suggests that the market has bought into 3M’s capital-deployment story. That hasn’t been the case with Danaher, which has risen just 0.3% during the same period. Morgan Stanley’s Nigel Coe and team wonder if the market thinks Danaher’s capital allocation model “is broken.” They explain:

With Danaher underperforming 3M and with its traditional P/E premium compressing from 15% to nothing, the market is clearly taking an overly bearish view that Danaher’s capital allocation model is broken. Note that Danaher now trades cheap on 2015 FCF, while 3M is the most expensive. In this light, we have to conclude that given the premium the market is paying for 3M's growth visibility – which is essentially replicated by Danaher – the Danaher capital deployment option value, which we estimate at $14 per share, is now a free option.

Shares of 3M have dropped 0.7% to $140.55 today at 10:04 a.m., while Danaher has fallen 07% to $74.66.