Don't Overlook 3M's Decline In Operating Income

| About: 3M Company (MMM)

Industrial conglomerate 3M (NYSE:MMM) reported relatively lackluster second quarter results. Organic local-currency sales grew 2.3% and earnings per share of $1.71 advanced 3% versus the same period a year ago, but operating income slipped due to material cost pressures. We also note the earnings-per-share growth was enhanced by a lower tax rate and share buybacks, revealing lower quality expansion (we prefer operating income growth-not just earnings-per-share growth). Still, free cash flow of $1.28 billion generated during the period exceeded net income and accounted for roughly 16.6% of sales.

3M's 'Health Care' division led the charge, with organic local-currency revenue advancing 5.7% in the period. The firm's 'Industrial', 'Consumer', and 'Safety & Graphics' segments also had a decent showing, with organic local-currency revenue jumping 3.3%, 2.9%, and 2%, respectively. The only division's revenue that declined in the quarter was its 'Electronics and Energy' operations, which fell 2.1% as a result of weakening end market demand (operating income at the division fell nearly 18%).

3M's 'Industrial' segment, the firm's largest operation, was bolstered by its acquisition of Ceradyne and strength in aerospace and automotive aftermarket products. Operating income advanced a meager 1.2% in the segment though. The company's 'Safety and Graphics' division was also augmented by acquisitive activity (Federal Signal Tech), though operating income fell nearly 10% from the same period a year ago. 3M's 'Health Care' segment revealed strength in health information systems, food safety, and critical chronic care, among others. But operating income only nudged higher 1.2%. The company's 'Consumer' performance was led by growth in home care and stationery & office supplies, but operating income only advanced 3.5% in this segment as well (which incidentally turned out to be the best operating-income growth across all of its segments, despite the meager performance). On a geographic basis, Latin America/Canada was particularly strong, growing 8.5%, while expansion in the US was weakest at 0.8% growth.

Looking ahead, 3M reiterated its 2013 full-year guidance of organic local-currency sales growth of 2%-5% and earnings in the range of $6-$6.85 per share. We note the latter will assuredly be bolstered by an increased share repurchase program (now $3.5-$4.5 billion, was $2-$3 billion). 3M continues to expect free cash flow conversion to be between 90%-100% for the year. Though we like the company's cash-flow generating prowess, we were not impressed by the direction of underlying segment operating performance in the period, particularly where operating-income declines are noted above. We're staying on the sidelines for now.

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