3M: Early-Cycle Exposure to Economic Recovery

As industrial markets have fallen over the past two years, companies previously bought hand-over-fist due to strong international presence have been put in their place; diversified product portfolios have become recession backfires; cost-restructuring plans and management shakeups have become costly uncertainties and cash has become the world's most valuable commodity. Despite the negativity, markets over the past few months have shown major signs of improvement as economic indicators from construction spending to consumer confidence continue to get “no worse.”

When we consider economic troughs, it is important to invest in companies with major exposure to the early-cycle. Our greatest conviction buy from the industrial sector of the market has been in 3M Corp.(MMM), an industrial conglomerate that manufactures everything from Post-It Notes to eco-friendly plasma television components. Companies like 3M with order books typically running a short 30-day time span will have major success through recovery periods, periods that typically propel equities higher for 3-4 months. To fully capture gains, it is prudent to look to companies like 3M for exposure to upside momentum in trading.

Invest When No News Is Bad News

We continue to value shares of MMM as “Buy” rated because the news seems to no longer impact shares to the downside. After missing 1Q2009 numbers handily, posting a $0.74 gain against analyst expectations of $0.85, 3M went from “bad” to “worse” by lowering their profit guidance on the year. What happened to shares? They traded up 5% on the day. With this in mind, we believe that as investors no longer respond to bad news from the company, we have seen a fundamental shift in the investment thesis… with investors unwilling to sell shares of MMM.

Now that the “bad news” on the company’s books seems to be out, we are faced with very beatable numbers for the year. In fact, upon running a discounted cash flow analysis, we find that the economic environment could show zero improvement from this point and the lower-end of guidance would still be reached.

Good News is Just Around the Bend

After 3M’s disappointing first quarter showing, Chairman George Buckley indicated that the company is seeing a bottom set in by the second-half of the year, more than likely late in the next quarter. Furthermore, although numbers missed our expectations across the company’s six business segments, we saw the company post stronger than anticipated operating margins to complement its relatively strong pricing power. Underlying decay in the weakest segments, namely in Display and Graphics, seems to be subsiding. If the bottom is truly in place, 3M is going to be riding pretty from here on out at an attractive 13x multiple.

The Global Recovery Starts With China

Our final point in making a bet on 3M is its powerful 25% exposure to the Asian markets, predominantly China. Despite obvious currency risk, we anticipate sales from China to recover before other nations. In our opinion, in-house stimulus will outweigh declines in U.S. imports in China and around the world to compliment 3M’s healthy 65% of sales from international markets. The Chinese stimulus package delivers an interesting opportunity for companies with exposure to deliver strong numbers regardless of real economic progress.

With shares of conglomerate powerhouse 3M now trading at a discount to the industry at a mere 13x earnings, we find ourselves faced with a fundamentally strong company at bargain-basement levels. After increasing its dividend, we continue to favor shares of 3M for early-cycle exposure at an attractive entry point on the backs of its beatable guidance, exposure to China, and oncoming strength.

The rest of this free research report “Stocks For An Economic Recovery” which includes commentary on all sectors is available for download at the following link.

Disclosure: None.

Comments

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After such an upbeat report why don't you have a position in MMM?

Jun 16 08:18 AM