Wall Street might be discounting AAR Corp, 3M, and Brunswick, but that doesn’t mean you should be as well.
These three companies aren’t so dissimilar. They’ve got rock-solid balance sheets and, by all accounts, are set to generate lots of free cash flow in the coming years. They also have attractive valuations at the moment. Here’s why aviation company AAR Corp. (AIR), industrial giant 3M (MMM), and leisure company Brunswick (BC) are good value for money.
Free Cash Flow Valuations
Free cash flow (FCF) measures how much money a company generates that management can use to do value-enhancing things for investors. It’s calculated after working capital requirement and capital expenditures are taken from net earnings. FCF can be used to pay off debt, pay dividends, repurchase stock, or even acquire funds. In theory, a company could use FCF to pay all of its dividends. That being said, a growing revenue base is obviously more attractive.
All three of the companies we’re going to discuss have plenty of FCF floating around. They’re priced relatively cheaply at the moment, but don’t let that make up your mind for you. Here’s why we think the market has got them all wrong.
The marine leisure company has actually been a winner due to the pandemic. Social distancing has meant that any sport where you can get away from others has been massively in demand. Marine leisure is, of course, one of the prime candidates for this kind of activity.
Short-term, the pandemic has proven to be a bit of a boon for this boating company. What worries investors, though, is long-term potential. As restrictions ease, some worry that this stock will be able to sustain its current momentum.
So far, those fears have been unfounded. According to the National Marine Manufacturers Association (NMMA), new powerboat sales were up 32% on a rolling 12-month year-over-year basis through April. In fact, the real problem is that supply hasn’t been able to keep pace with demand.
Brunswick actually makes more money from its propulsion, parts, and accessories than it does boats. In 2020, the propulsion part of Brunswick’s business generated $286 million in operating earnings, with parts and accessories achieving an equally impressive total of $275 million. That compares against a total of $70 million achieved just from boats. Ultimately, the parts and accessories side of Brunswick’s business turns over more operating and recurring revenue than just boats.
The substantial government support given to AAR hasn’t been able to totally offset the sheer scale of slump hitting the aviation industry, and the overwhelming majority of analysts are worried about the future of this industry. But, there is a growing body of evidence suggesting that travel is slowly working its way back to pre-pandemic levels.
Although flight departures are still significantly below 2019 levels, they are up 46% compared to this time last year. To aid with the streamlining of the business’ services, AAR CEO John Holmes has been shedding the company’s non-core assets, so when travel does eventually return in droves, we think this is a company that is well-placed to grow quickly again. How quickly we can expect any kind of return to normality in the aviation industry is difficult to predict, but the vaccination campaign is clearly having an effect, and that gives this industry every reason to be optimistic.
And there’s more good news. AAR has also been signing plenty of agreements, such as with United in order to maintain the company’s provision of United Airlines’ narrow-body fleet. All told, there are signs commercial flight is returning, and that makes AAR an exciting company.
3M is also looking good on an FCF basis. The company’s management has been hard at work over the last few years, restructuring its healthcare business, cutting costs, and changing the way the company makes money. Following from this, we think Wall Street is severely underestimating this stock.
So why are some investors reluctant? One reason investors might be apprehensive about buying this stock comes from the company’s potential liabilities related to its manufacture of perfluoroalkyl and polyfluoroalkyl substances (PFAS). It’s true that there are a couple of law suits relating to PFAS environmental contamination, but it’s not yet clear how any of these cases will relate back to 3M. The market though, seems to be assuming the worst.
In a similar position is Illinois Tool Works, and we can use this company as a useful case study in predicting how 3M’s stock may move. Based on current Wall Street prices, Illinois Tool Works trades at 26.6 times estimated 2021 FCF. Applying this same scale to 3M’s estimated FCF of $5.7 billion, we then have a target market capitalization of $152 billion for 3M. That’s nearly $35 billion higher than the company’s current market cap. That would make 3M’s current trading price an overly steep discount.
Liability or not, we still think that 3M looks to be good value for money and we’re suggesting that investors seriously consider this company again.