3M (MMM) is a well-diversified industrial conglomerate. It is one of the oldest and longest publicly traded companies in the US. A member of the Dow Jones Industrial Average index, with the market cap of $73B and annual sales of $30B.
If any company meets the longevity criteria of Warren Buffett and other long-term investors of a long history of regularly paid out and constantly increasing dividends, it is definitely 3M. It has been continuously paying a dividend since 1916 every single quarter. In the last 55 years, the dividend has also been increasing every single year. The average annual dividend growth rate was 7.5% over the last 40 years. The current dividend yield is 2.4%. Just to put this into a long-term perspective, Google (GOOG) didn't have its IPO ten years ago yet. Facebook (FB) didn't even exist ten years ago.
However, every company has its weak points and areas for improvement. I would like to go through those as well. If 3M succeeds in closing some of these performance gaps, it can accelerate its earnings growth and dividend growth even further. More importantly, it can leverage all the great hard-earned investments which it constantly puts into R&D and innovation.
- Current 3M share price is $105
- Trailing P/E is 16.73
- Forward P/E is 14.25
- PEG Ratio (5 yr expected) is 1.64
- Price/Sales is 2.45
- Price/Book is 4.15
- Revenue: $29.9B
- Profit Margin: 14.86%
- Total Cash: $4.53B
- Total Debt: $6.07B
- Operating Cash Flow: $5.3B
- Return on Assets: 12.37%
- Return on Equity: 26.61%
From the valuation and financial analysis, it is clear that the current 3M price does not give us an opportunity to buy this company at a truly value investor's dream valuation. Its current dividend yield of 2.4% is relatively low in historical perspective and the price-to-earnings ratio is relatively high. The stock is fairly valued and it is not a bargain. Let's have a look at 3M's recent P/E ratio chart:
However, if you compare 3M with similar companies, the average P/E for conglomerates is 15. And it is currently at 14.5 for the S&P Industrials sector. Thus, the current price of 3M is perhaps overvalued by 5-10% against the comparable sectors.
If we look at historical prices and P/E ratios of the industrial sector to determine where the valuations currently stand relative to historical averages, the current P/E ratio is close to long-term averages, perhaps 10% above average. Comparison to the long-term averages of the entire S&P sector yields similar results.
3M is a great company and a very safe investment for the long haul. However, every large company or conglomerate has its issues. If these are overcome, earnings and dividend growth may continue rising even faster.
1. 3M needs to develop strong marketing machine to leverage its innovativeness and high R&D spending
3M is one of the leaders in innovation. In 2012, they spent $1.6B on R&D, which is 5.3% of sales. Where 3M lags, as many large companies and conglomerates, is at being in contact with the customers. Being able to not only know what its customers want but also how to deliver to them a suitable product based on their existing or future needs. In other words, 3M needs better commercialization of its great innovations. Otherwise it will remain in a position similar to Xerox (XRX), which generated inventions that Apple (AAPL) and others commercialized.
It will not be easy for 3M to strengthen marketing, centralize it, integrate it with the main R&D centers, and at the same closely interconnect this R&D and marketing machine to many local clusters of important customers and distributors spread all over the world. An additional challenge is present due to the fact that most of 3M's products and inventions are targeted at business-to-business (B2B) customers, and mostly via distributor channels, which requires a very specific and challenging marketing approach.
2. Innovation value becomes discounted by fast-adapting competitors
Innovation is devalued sooner than ever before by savvy competitors, as I described in my recent article about Amazon (AMZN). Innovation no longer provides a long-lasting and long-term sustainable competitive advantage, if it is not backed up by fire-proof and defensible patents and strong protection from industrial espionage and blatant copying. Therefore, relying on innovation as the main competitive advantage can be dangerous in the long-term.
Moreover, the need for rapid innovation and shorter time-to-market cycles push against the need to optimize costs and keep prices competitively low. Therefore, the logical cost-cutting goal that many companies achieve through partial outsourcing of production to external producers in low-cost destinations, may result in a loss of close interconnection of R&D and production. Product innovation and product improvement in outsourced factories is much harder to facilitate than for the in-house-produced products.
3. Cost-cutting around the world means more demand for cheaper "good enough" products
3M is historically very strong in developing and providing high-end, high-quality solutions, which carry a high price tag and a high margin. Did you know, for example, that the first man on the Moon was wearing boots with soles made from 3M synthetic material? And that 3M duct tape was used as part of the workaround solution to save the Apollo 13 astronauts when it helped create the temporary lunar module's CO2 scrubbers? Or that 3M uses 3D printing technology in its healthcare division?
These are great inventions and high-end products. However, as Apple has learned twice in its history already, the first time with the personal computers, and the second time with the iPhone, the high-end segment is not infinite and needs to be balanced with lower cost products, if a company wants to achieve long-term stable growth. The caveat is in how to protect the high reputation of the brand if one sells average mass products as well. One feasible solution for both 3M and Apple is to build a separate low-end brand and still use all the synergies of the existing R&D, logistics, distribution, sales and marketing channels.
3M keeps constantly innovating and evolving. Just one example is the very recent decision made towards the end of 2012 to dissolve the worldwide underperforming division of Display & Graphics into two other divisions, to streamline the business and of course also to cut costs.
Due to the many facts mentioned in this article and many others which weren't mentioned, my conclusion is very positive for 3M. I am very confident 3M is a strong buy at today's prices for the long-term and dividend-oriented investors. The price seems to be about 10% above the fair valuation estimate. However, this is a reasonable price premium to pay for the top-notch performer which has been paying a dividend for over 90 years non-stop and increasing the dividends constantly for the last 55 years.
Investors today should look at 3M as a long-term stable dividend grower and as viable alternative to holding Treasuries or corporate bonds. With bond yields at historically low levels, 3M is a great replacement for bonds, even if it might not be historically "undervalued" as a stock. However, it is not expensive either, with a P/E ratio of 16.5 and a dividend yield of 2.4%. The average dividend growth was 7% over the last 20 years and 5-6% over the last 5 years. The risks of holding 3M stock are close to comparable to holding Treasuries or corporate bonds in the long-term.
I do not expect the price of 3M to drop by more than 10% throughout this year and expect it to be higher than today at the end of the year. However, in the short term, a mild correction which would take down the 3M stock as well, is possible and there are some risks to the upcoming season numbers as well as I described in my recent article.
My recommendation for long-term investors is a strong buy on 3M. From a tactical perspective of the actual trade execution, I recommend to start buying in May and spread the total allocated amount between 6 purchases of equal cash size, with one executed each upcoming month between May and October. The reasons why I recommend to wait until May and spread the purchases are listed below:
- Possible "Sell in May effect"
- Possible short-term risks for 3M price from the upcoming earnings season.
- Industrial sector's strong seasonality: the industrial sector stocks have one of the strongest seasonal price effects, where their price on average fell by .26% during the May to October summer months and rose by 9.14% during the November to April periods. You can read more on how Industrials are affected by seasonality here. Purchasing in the summer months will prevent us from buying at current seasonal highs.
- Spreading purchases will dollar-cost-average your purchase price and prevent you from a risk of a potential extremely disadvantageous timing of your purchase.
I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am a former employee of 3M