3M: Will Organic Growth Drive This Undervalued Giant?

| About: 3M Company (MMM)

For investors looking for an innovative large cap company that is creating shareholder value, 3M (NYSE:MMM) is a global company set up to do just that even in the face of volatile global markets.

3M is a global diversified industrials company that is focused on inventing. Founded in 1902 at the Lake Superior town of Two Harbors, Minnesota, five businessmen set out to mine a mineral deposit for grinding-wheel abrasives. Based from this original idea, the company has grown into a multi-billion dollar company with thousands of inventions that have impacted the daily life of people around the world.

3M serves their customers through five business segments. The division into five segments is designed to increase speed and efficiency throughout the company. The business segments are: Consumer, Electronics and Energy, Health Care, Industrial and Safety and Graphics.

Unlike one of 3M's biggest competitors General Electric (NYSE:GE), 3M does not have a financial segment of its business. GE's financial arm has been a drag on the company's overall earnings over the past few years, and with 3M this is not a concern. Currently, GE is working on reducing this segment of their business and focusing on being more of an industrial play. Until this segment is significantly reduced, I believe this will be a weight on GE's stock price.

Using the analysis below, I will analyze the past four years of 3M's performance. I will look at 3M's past profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future.


Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2010 = $4.085 billion
  • Net income 2011 = $4.283 billion
  • Net income 2012 = $4.444 billion
  • Net income 2013 TTM = $4.478 billion

Over the past three years, 3M's net profits have increased from $4.085 billion in 2010, to $4.478 billion in 2013 TTM. This represents a 9.62% increase.

  • Operating income 2010 = $5.918 billion
  • Operating income 2011 = $6.178 billion
  • Operating income 2012 = $6.483 billion
  • Operating income 2013 TTM = $6.469 billion

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three years, 3M's operating income has increased from $5.918 billion to $6.469 billion in 2013 TTM. This represents an increase of 9.31%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net income 2010 = $4.085 billion
    • Net income 2011 = $4.283 billion
    • Net income 2012 = $4.444 billion
    • Net income 2013 TTM = $4.478 billion
  • Total asset growth
    • Total assets 2010 = $30.156 billion
    • Total assets 2011 = $31.616 billion.
    • Total assets 2012 = $33.876 billion.
    • Total assets 2013 TTM = $34.130 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 13.55%.
    • Return on assets 2011 = 13.55%.
    • Return on assets 2012 = 13.12%.
    • Return on assets 2013 TTM = 13.12%.

Over the past three years, 3M's ROA has remained relatively consistent in the 13% range. This indicates that the company is generating the same income on its assets than it did in 2010.

ROE - Return on Equity = Net Income / Shareholders' Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

  • 2010 - $4.085 billion / $15.663 billion = 26.08%
  • 2011 - $4.283 billion / $15.420 billion = 27.78%
  • 2012 - $4.444 billion / $17.575 billion = 25.29%
  • 2013 TTM - $4.478 billion / $17.876 billion = 25.05%

MMM Return on Equity Chart

MMM Return on Equity data by YCharts

The ROE is showing a slight decreasing in profitability over the past 4 years. Since 2010 the ROE has decreased from 26.08% to 25.05%. As the ROE has decreased over the past four years, this reveals that there has been an decrease in how much profit has been generated compared to the amount that shareholders have invested, thus indicating a decrease in shareholder value.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total asset growth
    • Total assets 2010 = $30.156 billion
    • Total assets 2011 = $31.616 billion.
    • Total assets 2012 = $33.876 billion.
    • Total assets 2013 TTM = $34.130 billion.
    • Equals an increase of $3.974 billion
  • Total liabilities

    • Total liabilities 2010 = $14.493 billion
    • Total liabilities 2011 = $16.196 billion
    • Total liabilities 2012 = $16.301 billion
    • Total liabilities 2013 TTM = $16.254 billion
    • Equals an increase of $1.761 billion

Over the past three-and-a-half years, 3M's total assets have increased by $3.974 billion, while the total liabilities have increased by $1.761 billion. This indicates that the company's assets have increased more than the liabilities, thus adding shareholder value.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $12.215 billion
    • Current assets 2011 = $12.240 billion
    • Current assets 2012 = $13.630 billion
    • Current assets 2013 TTM = $13.983 billion
  • Current liabilities

    • Current liabilities 2010 = $6.089 billion
    • Current liabilities 2011 = $5.441 billion
    • Current liabilities 2012 = $6.200 billion
    • Current liabilities 2013 TTM = $6.335 billion
  • Current ratio 2010 = 2.01
  • Current ratio 2011 = 2.25
  • Current ratio 2012 = 2.20
  • Current ratio 2013 TTM = 2.21

Over the past three-and-a-half years, 3M's current ratio has increased. As the current ratio is above 1, this indicates that 3M would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 726 million
  • 2011 shares outstanding = 719 million
  • 2012 shares outstanding = 703 million
  • 2013 TTM shares outstanding = 683 million

Over the past three-and-a-half years, the number of company shares has decreased from 726 million to 683 million.

MMM Shares Outstanding Chart

MMM Shares Outstanding data by YCharts

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $12.831 billion / $26.662 billion = 48.12%.
  • Gross margin 2011 = $13.918 billion / $29.611 billion = 47.00%.
  • Gross margin 2012 = $14.219 billion / $29.904 billion = 48.03%.
  • Gross margin 2013 TTM = 14.362 billion / $30.270 billion = 47.44%.

Over the past four years, 3M's gross margin has dropped slightly. The ratio has decreased from 48.12% in 2010 to 47.44% in 2013 TTM.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $26.662 billion
    • Revenue 2011 = $29.611 billion
    • Revenue 2012 = $29.904 billion
    • Revenue 2013 TTM = $30.270 billion
    • Equals an increase of 13.53%.
  • Total Asset growth

    • Total assets 2010 = $30.156 billion
    • Total assets 2011 = $31.616 billion.
    • Total assets 2012 = $33.876 billion.
    • Total assets 2013 TTM = $34.130 billion
    • Equals an increase of 13.18%.

Over the past three-and-a-half years, the revenue growth has increased by 13.53% while the assets have increased by 13.18%. This is an indication that the company from a percentage point of view has been slightly more efficient at generating revenue.

Based on the analysis above, we can see that 3M has produced very strong results from a fundamental point of view. Revenues over the past three-and-a-half years have increased by 13.53%, the liabilities have increased by $1.761 billion while the assets have increased by $3.974 billion, thus adding shareholder value. Another indicator that the company is creating shareholder value is 3M's buyback program. In February 2013, 3M's board authorized the repurchase of up to $7.5 billion of 3M's outstanding common stock. Because of the buyback program, the amount of common shares have been declining. A blemish on the company's fundamentals are the results of the ROA and ROE. Both of these metrics have dropped over the past 4 years, and in my opinion, this is something to watch in the near future. Based on the metrics above, we can see that the company has produced very strong fundamentals.

Moving Forward: Focusing on Research and Development

As the world economy is currently volatile, the company's focus on organic growth through R&D (Research and Development) is expected to drive earnings over the next few years. 3M has been rapidly expanding operations around the world and now operates approximately 80 labs and technology centers globally. As the company has increased R&D spending, this is reflected in the New Product Vitality Index (NPVI). The NPVI is the percentage of net sales of products introduced within the last five years as compared to total net sales.

As the chart above indicates, the NPVI has increased significantly since 2009. Historically, the company has spent approximately 5% of revenue on R&D but as the company is focusing more on organic growth to cushion the effects of volatile global markets, President and CEO Inge G. Thulin plans to increase R&D spending to 6% or an approximate increase of $300 million a year. With the increase in R&D, CEO Thulin expects the NPVI to reach 40% by 2017. This focus on organic growth is expected to driving earnings, support the share buyback program and increase dividends for the 56th straight year, thus continuing to create shareholder value.


In the section below, I will use a couple of different methods to find a valuation of the stock price. In this section, I will use the Discounted Cash Flow valuation model and forward P/E ratios to estimate the current value of each share.

I believe using the Discounted Cash Flow valuation model for 3M to be fair because DCF analysis can help one see where the company's value is coming from and one can generate an opinion based on that.

Even though there are variations in calculating this formula, this model is based off of a terminal value of $93.528B and a WACC of 6.10%. The terminal value $93.528B is based off of the company trading at 12X EBITDA. Using these valuations, I have concluded 3M's value to be $134.82 per share.

In another method, I will use 3M's forward P/E ratios with estimated earnings to find the value. Currently, 3M has a forward P/E of 16.36 and FY 2015 earnings projected at $8.05. These two metrics lead to a target price of $131.70. I believe this to be a fair P/E ratio moving forward. As we look to be heading into a rising interest rate environment, P/E ratios tend to drop during this time.

As of October 17th, 3M's stock was trading at $120.94 - Using the Discount Cash Flow Formula, this indicates the stock is trading at a 11.47% discount to today's price. If I calculate a valuation using forward P/E ratios, this indicates a valuation $131.70 or a discount of 9.30%.

Currently, 3M's stock has a P/B of 4.62, which is above the industry average of 2.84, a P/S of 2.98 is above the industry average of 1.65 while a P/CF of 14.73 is well above the industry average of 12.3. Even though the ratios are indicating the stock is currently trading at the higher end of the spectrum, analysts see strong growth in the future.

Analysts' Estimates

Because of the company's focus on organic growth, analysts at MSN Money are estimating an EPS for FY 2013 at $6.71 while growth is expected to continue into 2014 as EPS estimates increase to $7.38.

Bloomberg Businessweek supports this idea as it expects the company's revenues to be around $30.9 billion for FY 2013 and increase to $32.6 billion for FY 2014.

Price Targets

  • Finviz has a price target for Dril-Quip at $122.60
  • Barclays gave the company an "equalweight" rating with a target of $118.
  • UBS gave the company a "buy" rating with a target of $128.


At this point, if you added a small position here and waited for a correction in the market, this would present an excellent opportunity to add a larger position. Based on seasonality, December and January have a history of being two of the weaker months for 3M, so an opportunity like that could be just around the corner.


Even though 3M's stock price has increased from $93.00 to its present price of $120 over the past 9 months, I believe the stock has upside from here. With the company's plan to increase organic growth through R&D spending, 3M is expecting be able to maintain strong earnings growth through a time of volatile global markets. Because of this plan, I believe this is an excellent time put this stock on your radar and wait for opportunities as a period of seasonal weakness approaches. At current levels using the Discount Cash Flow Formula, I have calculated that 3M is currently trading at an 11.47% discount to today's price.

Disclosure: 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.