How to Play the Conglomerate Market

By David Gould - September 25, 2012 | Tickers: MMM, GE, TYC | 0 Comments

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If you are bullish on the long-term trends of the economy, you should consider buying conglomerates. These entities are well diversified and are a good gauge on the overall health of macro trends. At the same time, only some, like GE and 3M are meaningfully undervalued in their existing forms while others, like Tyco, are only attractive through transformative alternatives.

3M

3M (NYSE: MMM) has solid fundamentals and positioned to accelerate in 2H12 as comps become easier. With a new CEO at the helm, the market is likely to become more speculative and produce greater swings in the stock price. Investors who believe in the company, however, should focus on the long-term and understand that 3M is a well managed and diversified business. While I think the company could do well selling off superfluous assets, I am against the idea of an overhaul and do not expect management to even hint at onel. I expect the company to maintain its EPS guidance of as high as $6.50 as macro trends improve visibility.

Equipped with a historically strong balance sheet, 3M can pursue more accretive takeover activity. Its global position is already pretty strong with more than a third of its business coming from emerging markets, which will pay off big when domestic markets lag and investors head towards higher-growth firms. Pricing/cost trends are also looking like they will offset FX headwinds at the same time that 3M continues to better navigate global ups and downs than peers. By virtue of its short-cycle business, I anticipate the company realizing positive growth in all of the regional markets for 2H12. Many commentators have grown negative on China; but, in my view, the region will do much better given the increased availability of credit. In fact, I anticipate China performing better this half of the year due to easier comps in electronics. Europe is still uncertain but appears to have normalized quicker than expected. I recommend buying to capitalize on these positive surprises.

Tyco (NYSE: TYC)

Tyco is another conglomerate that you may consider buying. With the SEC charge of foreign bribery behind (the company agreed to settle for $13 million), management can now focus on driving value creation. I believe that a possible breakup is underway. The business has seen greater hedge fund buying largely as a result of this speculation, which has risen from scrutiny over the planned sale of the pipes and valves division to, eventually, Pentair. According to management, the merger, pending shareholder approval, will help drive stock appreciation through efficiently streamlined operations.

Third quarter performance, however, was a mixed bag. The bottom-line was 33% below last year's third quarter. Results were weak enough that forecasts for fourth quarter have started to fall from $1.07 to $1.04. While asset sales could help the firm save in the long-term, holding the stock now through uncertain times would come at the opportunity cost of forgoing more undervalued picks right now.

All in all, Tyco is currently priced around peers, like General Electric (NYSE: GE), and is thus not substantially undervalued in the current form. Unlike Tyco, GE is not in need of a breakup and is slated for strong EPS growth. GECS has turned out to be a major cash flow generator while the 2009 macro stress test proved GE's strong financial position and economic moat. This strength across the board makes General Electric a "buy" over Tyco.

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