Dow 30 Stock Picks
The following stocks below are the six best stocks to own in the Dow.
Honeywell International Inc.
Current C.E.O: Darius Adamczyk
Honeywell Intl Inc's logo shown on the left.
Explanation:
Honeywell Intl Inc:
Originally Posted: June 17, 2022.
Update: June 17, 2022.
Incorporated by American industrialist Mark C. Honeywell in 1906, Honeywell operates as a multinational conglomerate organization focused on aerospace, performance materials and technologies, building logistics, and safety product solutions. Honeywell's historical and present-day inventions have significantly altered society. Company inventions span several industries, including automatic heating, unleaded gasoline, the barcode, biodegradable detergent, and low pollutant refrigerants. With a market capitalization of roughly $120 billion and annual sales of $34 billion, Honeywell continues to make its name known to customers worldwide. For over a century, Honeywell has delivered quality products worldwide. On today's note, although inflationary pressures and supply chain issues may pose concise term risk, Honeywell's operational excellence in its four segments makes the stock a buy.
However, before delving into Honeywell's strengths, I must mention the current economic state of high inflation and supply chain issues. Like its peers, inflation and supply chain problems will hit earnings. As a large consumer of raw material goods such as steel, copper, oil, and aluminum, heightened inflation and decreased supply have caused global commodity prices to rise. Also, labor shortages and global supply bottlenecks caused by pandemic-era facility closures affect Honeywell's ability to receive and process ordered raw materials. These issues pose problems to Honeywell's businesses and are apparent in the company's most recent earnings call. For the first quarter of 2022 earnings, Honeywell's operating expense rose 2.3% YoY to $7.105 billion. However, threats of heightened inflation and supply chain issues should not cloud Honeywell's bright future.
Importantly, Honeywell is a stable company. In the last 13 years, through the Global Financial Crisis and the Covid-19 pandemic, Honeywell's return on invested capital (ROIC) never fell below its cost. My estimates of Honeywell's business suggest that the company earns between 17-21% on invested capital, which is markedly higher than its 7% cost of capital. Unless Honeywell's businesses are overhauled or structurally changed, I am confident Honeywell will continue to outmaneuver any economic or health-related issues that could pose a risk to Honeywell.
Honeywell's best business segment remains its aerospace division. Honeywell designs, manufactures, services, and sells engines, auxiliary power units, and emission regulation and flight connectivity systems within the aerospace segment. Aerospace remains Honeywell's highest revenue and net income business. The division boasts margins of 27.4% as of Q1 2022. In comparison, Honeywell's biggest competitor General Electric (GE), posted an aerospace segment margin of 16.2% for Q1 2022, or 1,120 basis points below Honeywell. While
Honeywell's aviation margins fell by 1.6% from the quarter a year prior due, and net income fell 1% due to inflation and supply chain headwinds; sales and organic revenue grew by 4% and 5%, respectively. Honeywell was, for the most part, able to stay ahead of the inflationary curve due to solid price realization. Also, as the pandemic continues to ease and flight numbers exceed pre-pandemic levels, Honeywell's aviation segment should benefit. Also, it is essential to note that investors are under-appreciating the reality of longer flight hours. Specifically, the Federal Aerospace Administration (FAA) expects annual flight hours to increase from 24,500 hours in 2021 to 27,000 in 2031 and 29,250 hours by 2041. Increased engine use will increase the quantity of servicing, bringing cash to aerospace's aftermarket segment. Aftermarket servicing is where Honeywell generates the bulk of profits from manufacturing airplane and rotorcraft engines. Additionally, it is essential to note Honeywell's strong government ties. Government contracts pull the most weight in Honeywell's R&D spending (over 50%), and because they are government contracts, Honeywell receives the sales benefit without incurring additional expenses. In addition, Honeywell's good government connections and technical ability allow it to beat other competitors for government contracts. Moving forward, I am confident that Honeywell will continue outperforming its peers, serving the aerospace industry with a quality and dependable product while generating above-average returns.
Moving to Honeywell's second-largest unit, Honeywell Performance Materials and Technologies unit (PMT) is a recession-proof business. As renowned financial information services provider Morningstar noted, PMT's net income grew 14% even as oil dropped roughly 55% in the same year. With approximately 50% of sales in the oil and gas sector, as prices rise above $100 per barrel, Honeywell's PMT business is thriving. Additionally, Honeywell's PMT business works to reach sustainability standards through its software and data analytics technologies. As sustainability becomes more important in the coming years, PMT will spearhead the movement with its advanced software technology. Finally, PMT's most renowned product: The Solstice molecule, is a chemical agent used in several consumer items such as aerosols, refrigerants, and liquid cleaning liquids. PMT's Solstice molecule is used in several industries and meets and exceeds many environmental regulatory standards. Given Honeywell's rich track record of successful R&D investments, I believe that PMT can continue to manipulate and improve the Solstice molecule for more applications and, therefore, more meaningful use. In Honeywell's Q1 2022 earnings statement, PMT generated gross revenues of $2.453 billion, a 5% increase from a year prior. Additionally, segment profit grew 18% to 510 million. Lastly, PMT's margins stand at 20.8% (an increase of 230 basis points).
Honeywell's third-largest segment, Honeywell Safety and Productivity Services (SPS), offer the company the most significant growth potential. Working on automating workspaces such as factories and warehouses, SPS generated gross sales of $1.744 billion in Q1 2022, down 18% from Q1 2021. While these numbers don't seem enticing, a 14% margin for an industry in its early innings is relatively healthy. With 5% of automated workplaces, the SPS market is extensive. In 2021, analysts expect that by 2025, the industrial automation market will reach $265 billion, about $100 billion more than it's worth today. Companies will look to maximize profitability, becoming less reliant on humans for work and more dependent on automated products.
Honeywell's building technologies unit operates in two fields: building management services, fire and safety, sustainability, projects and services, commercial services, and electrical services. As of 2021, the building technologies unit generated minor revenue from Honeywell's four divisions. Specifically, team gross sales stood at $1.426 billion, a 5% increase from a year prior. Segment profit rose 10% from $305 million to $336 million due to increased segment revenue and operating efficiencies. Lastly, unit margins stand firm at 23.5%. As offices and housing look toward lowering their carbon footprint, companies and families will use Honeywell's unique array of equipment to help accomplish their goals. Additionally, the U.S government's infrastructure bill should directly benefit Honeywell. As governments rebuild airports, they will purchase high-tech security systems and airport machinery. Honeywell's long-standing government relationship and strong market dominance should win the company several contracts of the $15 billion awarded under the infrastructure deal. Additionally, the FAA estimates there is $43.6 billion in backlogs for airport renovations and updates, allowing for the opportunity. Also, as the pandemic ends, offices, schools, and companies are looking for safe ways to return to everyday life. A safe return to such workplaces opens Honeywell's post-pandemic safety market. This reality will attract consumers to Honeywell, driving up sales.
In conclusion, Honeywell's building technologies unit has a strong and stable market footing and room for large-scale growth. With continued R&D spending, Honeywell should continue to outperform its competitors. A post-pandemic reality, an infrastructure deal, and the inevitable world movement toward sustainability will push Honeywell's building technologies unit into the future.
However, I must mention the current economic state of high inflation and supply chain issues. Like its peers, inflation and supply chain problems hit earnings. As a large consumer of raw material goods such as steel, copper, oil, and aluminum, heightened inflation and decreased supply have caused global commodity prices to rise. Also, labor shortages and global supply bottlenecks caused by pandemic-era facility closures affect Honeywell's ability to receive and process ordered raw materials. These issues pose problems to Honeywell's businesses and are apparent in the company's most recent earnings call. For the first quarter of 2022 earnings, Honeywell's operating expense rose 2.3% YoY to $7.105 billion. However, threats of heightened inflation and supply chain issues should not cloud Honeywell's bright future.
Lastly, Honeywell's financials are solid. With $63.35 billion in assets and $19.37 billion in liabilities, Honeywell's debt/asset ratio stands at a healthy 0.32. Honeywell's $5.14 billion in free cash flow (2021) and the company's ability to generate positive free cash flow for the last decade suggest the company's suitable short and long-term investments. Honeywell's P/E ratio sits at a fair 23, but with excellent earnings growth prospects and efficient financial performance, Honeywell's stock has more to rise. Honeywell's dividend stands at a solid 2.2%, growing for more than five years. Also, I would like to add that the conglomerate structure has recently come into question. However, while some companies may benefit from splitting into different business units, Honeywell's businesses are intertwined. The same suppliers and IT software are used in Honeywell's businesses. I believe Honeywell's share price is $220 per share through continued operational superiority.
The Goldman Sachs Group Inc.
Current C.E.O: David Solomon
Goldman Sachs ticker shown above on the NYSE.
Explanation
Goldman Sachs:
Originally Posted: April 23, 2020.
Update: June 15, 2022.
Founded in 1869 by Marcus Goldman, Goldman Sachs (GS) has been involved in the investment banking industry for 151 years. As the second-largest investment banking company in the world, Goldman Sachs Corporation has a market capitalization of nearly $100 billion and annual revenues of approximately 60 billion, making it a lead pioneer in the industry. The company has nearly $3 trillion under management, making it one of the largest banks in the industry. Goldman is also quite diversified as it is involved with investment management, securities, prime brokerage, securities underwriting, and asset management. Through Goldman’s strong political presence and management, and good performance in its key businesses, I believe Goldman’s shares are a buy.
Lobbying Congress and higher officials have allowed Goldman to protect itself from specific regulations. For example, from 2010 to 2016, Goldman shelled out nearly $27 million in Federal Government lobbying. Additionally, Goldman has key former executives spread out throughout the White House. The former secretary of the treasury, Steve Mnuchin, and the former chief economic advisor to President Donald Trump, Gary Cohn, previously worked at Goldman. However, Goldman has proven to be reckless in its overseas dealings. The best example of Goldman's recklessness occurred when Goldman perpetrated the '1MDB' scandal in Malaysia. Ultimately, the scandal proved one of the biggest in corporate history as it forced down former Malaysian Prime Minister Najib Razak. In '09, the executives of Goldman created a fund that planned to build a financial district in Malaysia's capital, Kuala Lumpur. The fund began purchasing up to $12 billion in Malaysian debt and acquiring privately-owned power plants. However, while purchasing debt was legal, issues arose as most of the money raised was embezzled or laundered. Additionally, the principal perpetrator, Jho Low, took the millions of dollars raised and moved it to personal accounts while trying to disguise it as a 'legal business .'To this day, Low is still on the run. However, the DOJ has forced Goldman to pay a $2 billion fine. However, despite the company's fraudulent business dealings, in 2018, Goldman appointed a new insider, David Solomon, to take the top job. ​​
Moving forward, CEO David Solomon has provided the investment bank with a new goal: to attract the masses. For years, Goldman focused on luring wealthy clients into investing with the company. Solomon's new direction for the company will bode well for profits. It is projected that Goldman's latest platform, Marcus, will add to the company's nearly 7% net interest gain. Unlike rapidly growing Marcus, Goldman's other segments should provide the company with a stable footing in the industry. The investment banking unit will grow about 2-3%, while the trading unit will grow a small 1% over the next five years. Interestingly, 2020 proved to be beneficial to Goldman as profits surged. Specifically, Goldman's trading accounted for 93% of total revenue, and this helped the share price rise more than 100% into 2021.
However, while hyper trading will likely cool down, Goldman's share price gain will stay. While I predict Goldman's future doesn't offer excessive growth like other companies (as Goldman has been a well-established firm for some 100+ years), Goldman's excellent margins of 35% will benefit the company. Notably, due to the recent economic slowdown, large corporations will likely purchase smaller companies at a discount. This should help Goldman's securities underwriting business to provide a stable revenue stream. Additionally, over the long haul, every unit will present significant growth as many millennials become attracted to the company's various platforms. Important to note that Goldman's finance team expects the company to earn $2 billion-$3 billion from existing businesses and $1billion-$2 billion from new business ventures. Lastly, over the past 10 years, Goldman has created a stable and dependable revenue stream through its building of a virtual bank. As of 2021, Goldman had deposits of approximately $350 billion, up from $39 billion 10 years ago, giving the firm solidity. Put together, Goldman’s efforts have given Goldman a reputation of dependability, built on the company’s high quality investments and more recently, strong management.
It is essential to factor in the reality of the Federal Reserve's choice to raise interest rates when considering investing in Goldman. High inflation due to increased economic activity has put the economy on a teeter, and higher costs are weakening the consumer. However, while a recession may occur, it will likely be short. Goldman's financial strength, strong customer relations, and operational cost-cutting should protect the company from most risks. Additionally, higher interest rates will benefit Goldman as they can charge a higher rate on lent money. Specifically, the Federal Reserve is targeting interest rates to rise to 3.0-3.5 by year's end.
Furthermore, Goldman Sachs is a strong buy. Not to mention, as Goldman continues to grow, its dividend yield should rise. Goldman has provided shareholders eight years of increasing dividends and will only continue increasing shareholder returns. Currently, the dividend stands at 2.75%. Additionally, Goldman's low P/E ratio of 5.7 suggests that the company is significantly undervalued. For FY 2022 earnings, Goldman is on track to earn nearly $40 per share. Considering Goldman's low P/E ratio, stable growth and financial footing, and rising interest rates, my calculations suggest that Goldman's actual value stands at $422 per share.
Chevron Corp.
Current C.E.O: Michael Wirth
Chevron's logo shown in an advertisement.
Explanation
Chevron:
Originally Posted: November 13, 2021.
Updated: June 16, 2022.
Initially a part of John D. Rockefeller's Standard Oil Company, after acquiring the Pacific Coast Oil company in 1900, the corporation became known as the Standard Oil Company (California). However, in 1911 the Sherman Antitrust Act split Rockefeller's Standard Oil into several different companies. After that, the company changed its name to the Standard Oil Company of California. Today the company operates under the name 'Chevron' and continues to hold the Standard Oil Trademark name. Chevron Corporation operates as a multi-national energy company headquartered in San Ramon, California. Highly diversified Chevron works within the oil industry, including oil exploration and production (upstream), chemicals, oil refining, marketing, and transportation (downstream). Boasting a market capitalization of nearly $330 billion and revenues of $160 billion, the company ranks as the second-largest oil company in the U.S. and third-largest oil company globally. I believe Chevron’s stock is a buy through high oil prices, great operational efficiency, and leading sustainability commitments.
During the previous decade's latter half, oil prices remained low due to several factors. These determinants included: OPEC+'s increased oil output and the discovery of significant shale assets within the United States. However, I believe prices are set to rise in the near to long term. First, the Energy Information Agency predicts that global oil demand will continue to grow until 2035, plateauing until 2045, with demand falling after. Second, I believe that OPEC+ will not flood the market with oil. While OPEC+ attempted to bankrupt and stall the growth of American shale producers by increasing output and decreasing oil prices, they were unsuccessful. While the U.S. shale industry was affected, producers proved to be resilient. OPEC+'s decision to flood the oil market only lowered revenues for African, Middle Eastern, and South American oil producers while also damaging members of OPEC+'s oil profits. In the future, OPEC+ will look toward tightening the global oil supply as it aims to increase profitability for their governments and companies through higher crude prices. As the U.S. embarks upon a 'clean’ energy future, President Joe Biden's administration will look to constrain on-shore fracking to meet demands from the democrats as well as 'clean energy' initiatives. Lastly, oil is an un-replenishable resource. That said, American oil producers are beginning to see wells dry up, as, in years past, American producers focused on growth rather than value conservation. To continue operating, American producers MUST conserve their oil supply by limiting their BPD production. Chevron's current breakeven oil price as of June 2022 is $55 per barrel. With current oil prices trading at $120 per barrel, Chevron's profit margins are excessively high. Due to constrained oil supply, I believe that oil prices can average at current levels for some time. Not to mention, Chevron is primarily involved in several liquified natural gas (L.N.G.) projects. As oil prices rise, natural gas prices will follow in tandem, generating profits for Chevron.
Shifting focus, I will now discuss management at Chevron. Historically, Chevron stayed away from riskier oil assets in countries like Iraq and focused on its assets' quality. Specifically, Chevron operates on the belief of stability: running stable operations and avoiding certain political factors. The most significant representation of this strategy occurred when Chevron bought American oil producer Noble Energy in the second quarter of 2021. Through the purchase of Noble Energy for $5 billion, where oil prices traded at a meager $45 per barrel, Chevron's move represented its conservative approach to business: focusing on quality assets with room for value appreciation. This strategy has served all of Chevron's business units and shareholders well, with a return on capital invested of 6.15%. Chevron's R.O.C.E. remains slightly above the industry average of 6% and is stable, reflecting Chevron's priority of secure investments. Pushing Chevron's notion of 'stability' even further is Chevron's debt target. Currently, Chevron aims to hold the debt to capital ratio at 25% through efficient operating measures and value conservation, allowing the company to cover its large dividend even in times of industry weakness.
Additionally, while outstanding E.S.G. regulations pose risks for the company, Chevron has created future opportunities from the threat. Chevron's multi-billion dollar investments in hydrogen and renewable fuels create a pathway for the company to capitalize on the energy transition. Chevron's most recent Renewable Energy Group (R.E.G.) purchase for $3.15 billion represents the company's efforts to become cleaner. Such investments like Chevron's purchase of R.E.G. allow the company to continue serving the world's energy needs through 'clean fuels.' Notably, Chevron's advanced carbon capture program removes the environmental regulatory spotlight off Chevron, possibly saving the company billions of fines.
Lastly, Chevron's fundamentals are strong. In the years leading up to 2020, Chevron earned $13.50 per share in 2010 to $0.27 per share in 2016 (due to oil prices). Chevron is projected to reach $17.54 per share in 2022 and nearly $14.00 per share in 2023. Chevron's earnings numbers are historically high, and a rising share price should follow. Additionally, due to rising oil prices, Chevron's growing free cash flow (FCF) will cover the company's costs, including a rather hefty 3.7% dividend, and leave sufficient capital to be re-invested into e&p. Currently, at $170 per share, Chevron is slightly undervalued. Still, as a good hedge against economic downturns and high inflation, Chevron seems like a sure bet. Due to excellence in Chevron's strategy, rising oil prices, and increased strength in all of Chevron's business units, I believe Chevron can achieve $170 per share.
Caterpillar Inc.
Current C.E.O: Jim Umpleby
Caterpillar's logo shown to the left.
Explanation
Caterpillar Inc:
Originally Posted: August 21, 2021.
Update: June 19, 2022.
Founded in 1925, Caterpillar Inc (CAT) has emerged as the world's largest mining and construction equipment manufacturer. Caterpillar has built a vast portfolio through acquisitions, notably in the last 20 years, to support revenue of $50 billion and a market capitalization of $106 billion. For almost a century, Caterpillar Inc. has provided the best quality machinery for the construction and mining industries while ensuring stability through its natural resource extraction businesses. Although supply chain and inflation issues could slightly hurt CAT’s operations, I believe that Caterpillar’s stock is a strong buy through the company’s bright prospects, the end of the US-China trade war, and its large market presence.
​​
One can't help but refer to the U.S-China trade war when writing about large industrial companies such as CAT. The trade war, now three years old, will continue to persist into the very near future. When the trade war began, global steel and aluminum prices rose marginally, causing increased costs for CAT. However, with phase one of the trade deal already complete, it's only a matter of time before the two countries reduce or eliminate barriers. Even more promising, since Trump didn't win re-election in November, current President Joe Biden is looking for a way to support American citizens throughout the post-covid era. If President Biden ended the trade war, iron ore and aluminum prices would decrease, ultimately cutting costs for CAT.
Importantly as the pandemic nears its end, I continue to see it as a short-term issue that should resolve within 2022. Bigger growth promotions include the government-backed infrastructure project, which allocated nearly $550 billion to projects that would use Caterpillar's machinery. Due to the poor road conditions in America's urban cities, there is pent-up road construction demand. Additionally, the country's bridges and even airports need serious renovation. The first quarter of 2022 demonstrated North America preparing for such construction, as industrial sales rose 28% to $2.72 billion. Subsequently, investors should expect industrial sales to continue increasing as global and domestic demand for Caterpillar's machinery grows. Also, due to a rise in commodity prices, companies are investing heavily in oil and natural gas e&p. An increase in petroleum and gas e&p directly benefits Caterpillar in several ways. Companies demand more oil & gas extraction engines for drilling, increasing the need for servicing. Also, companies will need to transport higher volumes of oil and natural gas, benefiting CAT's transportation business. Oil companies' increased investment in oil & gas was represented in CAT's 2022 first-quarter earnings. Caterpillar earned $5.038 billion in its energy and transportation businesses, an increase of $531 million or 12% from a year prior. Similar to the increasing investment in oil and gas e&p, natural resource companies are heightening investment into commodities due to rising global natural resource prices. Caterpillar's resource industries segment caters to the needs of heavy equipment in mining, quarry, waste, and material handling applications. CAT's first-quarter sales in its natural resources business rose by 30% from a year before to $2.83 billion. Investors should continue to expect sales growth in CAT's three business segments throughout at least the first half of 2022.
To top it off, Caterpillar will remain the sole beneficiary of increased investment in oil and gas e&p, natural resource extraction, and heavy machinery as its competitors trail CAT's 13.2% global market share. While companies like John Deere, Doosan, Komatsu, and Hitachi compete with Caterpillar, they follow CAT's sales and product quality in every business segment.
In addition, Caterpillar has an enormous economic moat. The extent of Caterpillar's brand name has given it the 82nd most valuable brand in the world, totaling a value worth $5.42 billion. Project sites use Caterpillar's machinery in almost every construction, oil & gas, or mining site. Additionally, Caterpillar has nearly 20,000 patents and e-commerce platforms, and retail stores sell CAT's smaller items such as boots and other accessories.
More pressing, soaring inflation and supply chain issues are increasing costs for industrial companies. Specifically, copper, steel, and aluminum prices (all components within CAT's product line) have risen, adding to CAT's total operating expenditure of $11.74 billion for the first quarter of 2022. Compared with Q1 2021, total expenses stood at $10.073 billion, or $1.66 less than the current quarter. However, these are short term issues and should resolve within the next 8-10 months.
Lastly, Caterpillar's cash flow remains on a growth trajectory, focusing on one of the most critical metrics in an industrial company. Since 2016, when Caterpillar reported a positive free cash flow of $3.61 billion, the number has grown. For fully 2021, free cash flow stood at $4.73 billion, representing a substantial increase from 2016. While CAT's total debt is 46% of the company's assets, its debt-to-asset ratio is significantly better than its competitors. For example, CAT's largest competitor, John Deere, has a higher debt-to-asset ratio of 0.55. With strong and consistent positive free cash flow numbers, Caterpillar can keep a healthy balance sheet while continuing to invest in r&d. Additionally, Caterpillar's EPS has grown an extravagant 734% from the financial crisis lows. Specifically, CAT's full-year 2009 EPS stood at $1.43 per share. For FY 2021 earnings, Caterpillar's EPS stood at $11.93. Notably, Caterpillar pays a 2.5% dividend which has increased yearly for 28 years. CAT's ever-increasing dividend coupled should reward long-term investors. Lastly, CAT has a P/E ratio of 16.08, lower than the S&P average. Due to Caterpillar's solid financial data, projected revenue growth, and ability to weather an economic downturn, I assigned CAT a price target of $260.
The 3M Co.
Current C.E.O: Mike Roman
3M Co's logo seen to the right.
Explanation:
3M Co.
Originally Posted: August 2, 2022.
Updated: August 2, 2022.
Formerly known as the Minnesota Mining and Manufacturing Company, the 3M Company is a multinational conglomerate headquartered in Saint Paul, Minnesota. Founded by five businessmen, Henry S. Bryan, Hermon W. Cable, John Dwan, William A. McGonagle, and J. Danley Budd, 3M was incorporated in 1902. Since 3 M's founding, the company has diversified into several different industries. 3M derives its revenues from sales in its four divisions: Safety and Industrial, Transportation and Electronics, Healthcare, and Consumer. In the trailing twelve months (TTM), 3M generated revenues of $35.33 billion and amassed a market capitalization worth $80 billion. With over 100,000 patents, 3M Co is an innovative core industrial company at heart. While a looming recession and litigation fears have pummeled 3M shares, I believe overblown threats cloud 3 M's robust business model, growth opportunities, and operations.
In 3 M's second quarter 2022 earnings call, the company announced that its ear-plug production unit, Aearo Technologies LLC, will file for chapter 11 bankruptcy. Seeded in 2018, lawsuits from former U.S veterans arose and alleged 3M of creating a faulty design of its Combat Arms earplugs. In July 2018, 3M Co agreed to pay $9.1 million to the U.S Department of Justice to settle the faulty earplug claims. Today, more than 230,000 service departments or former military personnel have filed a lawsuit against 3M. From a statistical point of view, each payout has averaged from $50,000 to $300,000, suggesting that 3M may incur heavy losses. However, due to Aearo's recent chapter 11 bankruptcy filing, most litigation fears will diminish as it is hard to prove a business entered bankruptcy to avoid one's litigation. Additionally, 3M has set aside a $1 billion trust to payout any plaintiff litigation against that company that is successful. Essentially, now that Aearo has filed for bankruptcy, litigation fears are overdone and are leading to an under-valued share price.
Additionally, 3 M's diversified portfolio of products should keep company earnings ahead of the GDP curve. While recent GDP data showed the U.S entering a recession, 3M Co's reach into the automotive, commercial solutions, energy, healthcare, transportation, safety, electronics, and consumer goods industries should guard the company. Specifically, 3M derives roughly $13 billion in sales, or approximately 40% of its 2021 revenue, from economically defensive industries like government contracts, safety, and healthcare. While 3 M's may decline very soon due to slightly poorer economic conditions, 3 M's short cycle traditionality makes it outperform in the early stages of an economic recovery.
Notably, 3 M's businesses are well positioned to capture top line and above economic growth in the years to come. First, 3 M's safety and industrial business, producing abrasives, adhesives, and tapes can apply in the aftermarket auto, renewable energy, safety, and electrical markets, offering the company solid growth. Specifically, the safety, renewable energy, and aftermarket automotive industry are expected to grow at a 10.4% CAGR from 2020-2025 and an 8.4% and 3.4% CAGR from 2021 to 2030, respectively. As of Q2 2022, 3M reported (non-GAAP) net sales of $2.92 billion on margins of 26.5%. Net income came down roughly 5%, and margins stumbled by 2%. Inflationary pressures are to blame. 3 M's safety and industrial segment reported a net operating loss of $707 million, mainly due to litigation costs of $1.337 billion against 3M regarding the faulty ear plugs case. However, as inflation and litigation abate due to Aearo Technologies's planned chapter 11 bankruptcy, net income and revenues should rise.
3 M's second largest business, Transportation and Electronics, creates products for the infrastructure, aerospace, advanced materials, and commercial solutions industries. Specifically, as pandemic-related issues in the aerospace market abate and plane suppliers like Boeing have a backlog of 4,239 planes, airplane manufacturers will demand 3 M's engine components, paints, composite parts, and interior device structures. Additionally, a long-awaited infrastructure program is on the horizon. Government contracts worth $ 100's millions to billions of dollars should roll out to 3M for its reflective coatings, adhesives, and insulation products. Analysts expect the critical public infrastructure and aerospace parts market to grow 11.4% on a CAGR basis until 2027 and at a 6.1% CAGR until 2025. As of Q2 2022, 3M reported net sales of $2.33 billion on 25.4% margins. While 3 M's margins fell by 0.8% and revenue dipped nearly $100 million from Q1 2021, inflationary pressures are to blame. However, 3 M's mid-long term outlook excites me, not unsustainable inflationary pressures.
3 M's third largest business, Health Care Business Group (HCBG), produces products for the global healthcare industry. Specifically, HCBG creates and designs healthcare solutions, separation and purification sciences, drug and food safety ingredients, oral care devices, and health information systems. As of 3 M's second-quarter earnings, the company announced it would spin off HCBG into a separate company. HCBG earned $2.179 billion in net revenues on 22.7% margins. While HCBG's net income rose slightly YoY, margins fell by 260 bps due to manufacturing productivity, high inflation, and the planned separation of its drug and food safety business unit. However, as a stand-alone company, HCBG's management can become laser-focused on driving growth and shareholder value for the business. Analysts expect the global healthcare industry to grow at a 7.8% CAGR.
Lastly, 3 M's Consumer Business Group (CBG) produces items for the home improvement, office supplies, and consumer healthcare industries. Most notably, 3M owns brands like Post-It and Scotch that generate many of CBG's profits. In 3 M's 2022 second-quarter earnings, CBG generated a net income of $1.330 billion on margins of 21.4%. While net income fell by $100 million from a year prior and margins dipped 1.9%, as CBG is 3 M's most inflation-exposed business, investors saw CBG's net income and margins falling. However, CBG is a dependable and stable business for 3M and should continue to yield solid returns as the global economy gains steam sometime in 2023.
Looking at 3 M's profitability ratios, 3 M's ROIC was 14.03%, while return on equity (ROE) reached 28.57%. Also, 3 M's gross profit margins (GPM) stood at 26.3%, while net margins (NPM) were 11.83%. Compared to the specialty industrial goods industry, 3M is an outperformer. The industry average for ROIC, ROE, GPM, and NPM stands at 9.8%, 19.5%, 12%, and 6.05%, respectively. If 3M needs to liquidate its assets quickly, 3M can do so as its quick and current ratio is 0.8 and 1.47, respectively. 3 M's P/E ratio stands at 20.03, and its dividend sits at 4.22%, cushioning investors with cash.
Overall, 3M is a fantastic business, and disregarding short-term legal issues and economic factors, I believe 3M will incur future stability and steady growth. 3 M's fair value comes to $192 per share.
The Home Depot Inc.
Current C.E.O: Edward Decker
The Home Depot Inc's logo seen to the left.
Explanation
Home Depot Inc:
Originally Posted: June 21, 2022.
Updated: June 21, 2022.
The Home Depot was founded in 1978 by Bernie Marcus and Arthur Blank. Although a relatively young company, through its high-quality products, excellent customer service, and reputation as the best DIY (Do It Yourself) store in business. The Home Depot is the world's largest home improvement retailer with gross sales of $151.2 billion and a market capitalization of $280 billion. Unlike most corporate structures, which boast consumer priority (but in reality prioritizes bureaucratic corporate networks), Home Depot does put the consumer first. Home Depot's utilization of the inverted pyramid structure speaks for itself, placing less importance on the corporate. Home Depot must base its business around consumer patterns and changes because if not, competing retailers like Lowes can detract consumers from Home Depot, offering better products with less competition. Home Depot's more than 2,300 stores in Mexico, the U.S., and Canada give the company a strong presence in its operating markets. Although inflationary pressures could hurt Home Depot due to growing real-estate demand and the company's large size, I believe Home Depot will generate strong returns.
While the Federal Reserve targets interest rates to reach 3.0%-3.5% by year's end, this number is historically low. Specifically, in the interest rate hike cycle before the 2008 financial crisis (2004-2008), interest rates rose to 5%, and before that, fund rates ranged from 20% in 1980 to 6.25% in 2000. The only interest rate hike cycle having peak rates below current cycle targets was the rate hike cycle of 2016-2019, reaching only 2.5%. History shows that even when federal fund rates averaged 6% from 1990 to 2000, housing prices rose about 42% in the ten years. Other than a short and soft recession that may hit by year's end, the housing market will steadily grow as long as federal interest rates stay below 5%. Since The Home Depot is the world's largest home improvement retailer, a growing housing market would directly correlate to increasing revenues. Home Depot's H.D. supply line would benefit from increased home building. Even if homebuilding and the economy slows, consumers tend to stay indoors and embark on DIY projects, giving growth opportunities to Home Depot's maintenance and repair operations (MRO) business. Home Depot's MRO business removes cyclicality from the company, as there is always a constant need for repair and improvement. The median age of a U.S. home is 37 years old, making home repairs necessary. As the median house age continues to rise, more and more repairs will be required, driving sales for MRO. Additionally, Home Depot will continue to capitalize on product lines in weaker retailers as it did with Sears. Because of Sears's failure today, Home Depot sells appliance brands such as Siemens, Maytag, and Haier. As of 2021, Home Depot had $7.9 billion in cash or cash equivalents, ultimately allowing the company to take advantage of any weakness in its business peers. Unlike Home Depot, Lowe's (Home Depot's closest competitor) can not do the same due to its significantly smaller, $1.4 billion cash pile.
Home Depot's size gives the company an advantage over its competitors. First, Home Depot's significant presence with thousands of stores across North America keeps the company as the best home improvement store at the forefront of consumers' minds. Home Depot creates customer loyalty by passing some of its savings back to the consumer through its low pricing. Intentionally, Home Depot can retain its customers, fending off its industry peers, and ultimately keep revenue streams stable. Additionally, Home Depot's large size gives the company better pricing power than its competitors. It is in the manufacturer's best interest to succeed in Home Depot's demand for low costs, as without Home Depot, suppliers could not get through to the open market. With that said, suppliers will look to continuously strengthen their ties with big retailers like Home Depot, giving little room for the possibility of direct contact between supplier and merchant.
I should also make note that Home Depot makes it mainly insulated from e-commerce platforms. The size and heavy weight of the company's products make it illogical for e-commerce players to transport similar products. Over the last five years, Home Depot has generated roughly 33% in returns on invested capital (ROIC) and should continue to do so, thanks to its unique setup.
Lastly, Home Depot's financial metrics suggest the company is in good shape. Rising revenue, net income, and EPS in its income statement ($110 to $151 billion, $11 to $16 billion, and $10 to $15 per share) over the last two years demonstrates the company's focus on cost-cutting, operational excellence, and growing sales. Looking at Home Depot's balance sheet, debt remains at a high asset-to-debt ratio of 0.62. However, due to Home Depot's continued and future growth prospects, I believe the company's debt is manageable. Currently, the company generates $14 billion in free cash flow annually, helping pay down its annual debt of roughly $42 billion. Lastly, the company has a price-to-earnings ratio (P/E) of 17. While the company's P/E suggests the stock is slightly undervalued, I see Home Depot as a deep-value buy. Its consistently growing dividend for the last 5-10 years (now at 2.8%), the business's firm footing, and increasing revenues suggest that Home Depot's share price is relatively undervalued. Over the past six months, the company's share price dipped from a peak of $420 to $290 per share. At these prices, Home Depot's stock is trading at a bargain. Home Depot's fair value comes to $380 per share.