Here’s why 3M stock could rise at least 28% based on management’s plans

So far, investors in 3M (MMM -0.09%) you will know that the stock appreciated significantly after the presentation of the results of the second quarter. While the full-year earnings outlook has improved slightly, the share price surge is likely more attributable to new CEO William Brown’s outline of his plan to generate value for investors. I want to focus on a key part of his plans, which is that investors could see a substantial increase in the share price.

3M’s new CEO is making plans

Brown’s comprehensive presentation emphasized the need for 3M to grow organically and improve margin performance by rejuvenating its research and development (R&D) activity to drive new product introductions (NPIs). This goal fits 3M’s research and development model to create differentiated products that hold pricing power and drive volume growth. In turn, the increase in volume leads to an expansion of the margin due to the production size of the building and a decrease in the cost per unit.

That said, it will take time for a shift in research and development to materialize, so in the short term, Brown said the focus will be on “commercial excellence to sell more of what we currently offer and that means a better sales force and distributor. effectiveness”.

Brown’s plans are numerous, but one aspect, reducing inventory as a share of cost of goods sold, is exciting and could lead to significant increase in shareholder value.

Why inventory reduction is important

Brown argued that “we have too much inventory at about $4 billion,” and explained, “Our bottom-up analysis indicates that we should be closer to 75 days of inventory or less, which would involve a cash opportunity of approximately $1 billion over time.” Let me unpack these statements and why they are so important.

Image source: Getty Images.

Inventory means the value of salable goods, work-in-progress and raw materials held by the company at any given time. The higher the stock, the more cash the company has in it. Inventory is usually compared to cost of goods sold (COGS) to measure how many days in a year it is held before it is sold.

Digging into the numbers:

• As Brown noted, inventory at the end of the second quarter was $4.06 billion.
• COGS was $3.57 billion in the second quarter.
• So inventory divided by COGS was 1.137 in the second quarter, and since a quarter includes approximately 365/4 days, that means 3M holds 1.137*(365/4) = 103.8 days of inventory in a year.

A quick look at 3M’s long-term days stock (a higher number is worse) confirms the deterioration of 3M’s number over time.

MMM (Yearly) Days Inventory Outstanding Data by YCharts

Brown plans to reduce days of inventory outstanding to 75 days, a figure closer to that of his industrial company. Illinois Tool Works. Doing so will free up a lot of money.

MMM (Yearly) Days Inventory Outstanding Data by YCharts

Playing with some numbers, if 3M’s inventory days outstanding had been 75 days, then quarterly inventory over COGS would be 0.82. With COGS at $2.94 billion, that means Brown’s target stock would have been $2.94 billion, rather than the $4.06 billion reported at the end of the second quarter , a difference of $1.1 billion.

What saving $1.1 billion in stock could mean for 3M’s stock price

Wall Street believes 3M’s free cash flow (FCF) will average about $3.9 billion over the next three years. If 3M frees up $1.1 billion in cash, that number could be $5 billion, representing a 28% increase from its average estimate of $3.9 billion over the next few years. As such, if the market values ​​the company at the same price to FCF ratio, 3M could have a 28% stock appreciation.

Image source: Getty Images.

Furthermore, as the chart above shows in relation to Illinois Tool Works management beginning a fundamental restructuring of the company in 2013, days of inventory are likely to decrease. Moreover, as the inventory reduction implies, an increase in cash flow may occur as management works to improve 3M’s organic growth rate.

Overall, if Brown pulls off his inventory plan, 3M stock is likely to rise significantly.