3M Company: Rich, But Not Too Rich

 |  About: 3M Company (MMM), Includes: FIDU, FXR, IYJ, PRN, PSCI, RGI, SIJ, UXI, VIS, XLI
by: Selling Theta

3M Company (NYSE:MMM) had a significant run-up of more than 40% over the past 12 months. As a result run-up, the future forecasted returns are compressed to the high single digits based on consensus estimates. Given the Company's high moat around the businesses though, I think this one is a keeper.


3M is a diversified technology company with a global presence in the following businesses: Industrial and Transportation; Health Care; Consumer and Office; Safety, Security and Protection Services; Display and Graphics; and Electro and Communications. 3M is among the leading manufacturers of products for many of the markets it serves. Most 3M products involve expertise in product development, manufacturing and marketing, and are subject to competition from products manufactured and sold by other technologically oriented companies.


2008 2009 2010 2011 2012
Revenue $25,269 $23,123 $26,662 $29,611 $29,904
% Growth n/a -8.5% 15.3% 11.1% 1.0%
Gross Profit 12,012 11,124 12,831 13,918 14,219
% Margin 47.5% 48.1% 48.1% 47.0% 47.5%
EBITDA 6,681 6,180 7,038 7,414 7,771
% Margin 26.4% 26.7% 26.4% 25.0% 26.0%
Net Income 3,460 3,193 4,085 4,283 4,444
Avg Diluted Shares 707.2 706.7 725.5 719.0 703.3
% Growth n/a -0.1% 2.7% -0.9% -2.2%
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Note: All figures are MM's (except per share data) unless noted otherwise.

3M has been relatively flat over the past five years. The Company's revenue contracted only once at a rate of 8.5% in 2009. In spite of the one year contraction, the Company managed a positive compounded annual growth rate of 4.3% over the past four years. The gross margin hasn't moved much, staying within a tight 1.1% range over the past five years (bottoming at 47.0% and peaking at 48.1%). On the other hand, EBTIDA Margins have contracted from 26.4% in 2008 to 26.0% in 2012. However, EBITDA expanded from $6,681MM in 2008 to $7,771MM in 2012 (16% expansion) over the five year period as a result of the revenue growth.

Per Share Data
2008 2009 2010 2011 2012
Revenue $35.73 $32.72 $36.75 $41.18 $42.52
% Growth n/a -8.4% 12.3% 12.1% 3.2%
Gross Profit 16.99 15.74 17.69 19.36 20.22
EBITDA 9.45 8.74 9.70 10.31 11.05
Net Income 4.89 4.52 5.63 5.96 6.32
Dividends 2.00 2.04 2.10 2.20 2.36
Payout Ratio 40.9% 45.2% 37.3% 36.9% 37.3%
Dividend Growth n/a 2.0% 2.9% 4.8% 7.3%
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Note: Per share data based on weighted average diluted shares outstanding.

On a per share basis, there isn't much additional to identify. The Company had relatively flat weighted average shares outstanding, only slightly decreasing from 707MM to 703MM over the period (a 0.6% decrease). EBITDA per share has expanded from $9.45 to $11.05 (a 17% increase as compared to a 16% increase at the Company level). The Company's dividends per share have been growing, increasing from $2.00 per share in 2008 to $2.36 per share in 2012 (a 18% increase or a 4.2% compounded annual growth rate), while maintaining a stable payout ratio in the 40% range. It's also important to point out 3M recently significantly increased it's quarterly dividend to an annualized rate of $3.44, which would bring the 2012 payout ratio up to ~54% on a proforma basis.


Market / Par Value EBITDA Multiple
- Cash and Equivalents $3,311 0.4x
+ Total Debt $5,777 0.7x
+ Minority Interest $456 0.1x
+ Market Capitalization $91,910 11.7x
Total Enterprise Value $94,832 12.0x
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Note 1: Based on TTM EBITDA of $7,876MM as of 9/30/13.

Note 2: Market Cap based on 665.2MM shares outstanding and a $138.16 market price as of 1/16/14.

3M has an under leveraged capital structure. The Company is levered at 0.7x TTM EBITDA (0.3x net of cash) with a total enterprise value of 12.0x TTM EBITDA. The Company could easily increase this to a more meaningful level at a low cost to leverage their equity returns. Even with moderate leverage the Company would retain a low cost of debt and maintain significant financial flexibility, while enhancing returns to the equity holders.


2013 2014 2015 2016 2017
EBITDA $8,028 $8,661 $9,199 $10,027 $10,549
% Growth 3.3% 7.9% 6.2% 9.0% 5.2%
Interest Expense 157 157 157 157 157
Taxes 1,828 1,976 2,101 2,294 2,416
Capital Expenditures 1,660 1,791 1,902 2,073 2,181
Dividends 2,275 2,275 2,275 2,275 2,275
Addl' FCF $2,107 $2,462 $2,763 $3,226 $3,518
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Note: All figures are MM's (except per share data) unless noted otherwise. Consensus Estimates only relate to EBITDA projections. All other assumptions are based on unadjusted LTM actuals.

The consensus estimates for 3M are moderate to aggressive, projecting a growth rate between 9.0% and 3.3% annually through 2017 at the EBITDA line. Under the consensus case the Company is projected to have significant additional free cash flow available to reinvest in the business, repurchase shares (always assumed for modeling purposes), or increase the dividend.

2013 2014 2015 2016 2017
Addl' FCF $2,107.4 $2,462.0 $2,763.4 $3,226.6 $3,518.8
Share Redemption Price $158.88 $182.72 $210.12 $241.64 $277.89
Shares Redeemed 13.3 13.5 13.2 13.4 12.7
Wtd Avg Diluted Shares 665.2 651.8 638.6 625.3 612.6
Dividends Per Share $3.42 $3.49 $3.56 $3.64 $3.71
Dividend Growth 44.9% 2.1% 2.1% 2.1% 2.1%
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The share redemptions are assumed to be at a 15% annually compounded price. I believe that this is structured very conservatively. If the weighted average redemption price exceeded this threshold, the investor would have ample opportunity and time to re-evaluate their position and consider selling their position for a gain from today's price. The Company's share redemption would allow for a 2% increase in the dividend annually from the share redemptions alone. Additionally, the Company's payout ratio would decline as the dollar amount of dividends paid would not be increasing while the Company's earnings (using EBITDA as a proxy) would be increasing.

If the Company performs in line with the consensus estimates and pay dividends / redeems shares as outlined above, the Company would achieve the IRR / Cash on Cash returns illustrated below, based on the outlined terminal EBITDA multiples.

Returns Based on Terminal EBITDA Multiple
9.5x 10.0x 10.5x 11.0x 11.5x 12.0x
IRR 5.6% 7.0% 8.3% 9.6% 10.8% 12.5%
Cash on Cash 1.23x 1.29x 1.36x 1.42x 1.48x 1.57x
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At today's prices 3M is fairly valued. Over the next few years I think we will see management succeed in growing the business on the top and bottom lines, but we may have some contraction in the valuation multiple around a turn or so to 11x TTM EBITDA. I own the stock today and will continue to hold (for the foreseeable future) due to its high moat for most of the business lines. I've decided I'd be happy with only a high single digit return, which is where I think this one will shake out.

Disclosure: I am long MMM, . 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.