3M: Extremely Well-Led Business Is Appealing If A Correction Takes It To General Market Multiples

| About: 3M Company (MMM)


3M reports uneventful second quarter results.

Continued organic growth, margin expansion and increased R&D should boost growth and earnings for years to come.

Combined with appealing dividends and share repurchases, shares offer appeal on a 10-15% dip which brings the valuation at par with wider equity markets.

The 3M Company (Minnesota Mining and Manufacturing Company) (MMM) reported a solid but non-eventful second quarter earnings report on Thursday. This is as investors focus on steady long-term organic growth following the company's 2017 targets released earlier this year.

I like the company behind the famous Post-it notes and Scotch tape very much, but not necessarily at this price. Following a 10-15% correction I might be willing to pick up some shares in this long-term quality player.

Second Quarter Highlights

3M posted second quarter sales of $8.13 billion, up 4.9% compared to last year. Revenues came in a bit ahead of consensus estimates at $8.08 billion.

Thanks to cost control and operating leverage, 3M managed to report a 5.8% increase in net earnings to $1.27 billion.

Diluted earnings per share came in at $1.91 per share and were up by 11.7% thanks to rather sizable share repurchases. Earnings were in line with consensus estimates.

Looking At The Business Segments

3M's reported sales growth was driven by each of its individual business segments. Strength was seen in the US, EMEA and Asia-Pacific in particular, offset by a 3% sales decline in Canada and Latin America due to depreciation currencies.

Overall 4.9% sales growth was of good quality, driven by organic volume growth of 3.5% while prices were up by just 1.3%. The remaining 0.1% growth was explained by minor acquisitions while FX rates had a net flat effect on sales in dollar terms.

The company's largest industrial segment posted sales of $2.81 billion, a 4.9% improvement from last year. Sales were led by the purification, automotive OEM, aerospace and transportation business. Operating margins were under a bit of pressure, but margins of 21.9% remain very impressive.

Safety & Graphics is the second largest segment and its sales were up by 4.2%. Personal safety and commercial solutions drove results, offset by weakness in roofing granules, which is not surprising after Owens Corning (NYSE:OC) warned about the roofing business in recent times. Operating earnings rose by 7.6% as 3M managed to find more opportunities to expand its operating margins to 23.6% of sales.

Electronics & Energy revenues rose by 6.1% to $1.42 billion making it the quickest growing segment within the firm. The results were driven by the electronics business, which grew in their double digits while energy sales were up by just one percent. More importantly, operating earnings rose sharply and were up by 23.6%, resulting in operating margins of 20.6% of sales.

Healthcare revenues were up by a solid 6.0% for the quarter and totaled $1.42 billion as well. Sales were driven across all the subsegments of the unit. Acquisitions added roughly 20 basis points in sales growth for the segment. Earnings rose by little over 4%, but despite earnings growth trailing topline sales growth, margins of 30.6% remain very impressive.

At last is the consumer segment, which posted a 3.7% increase in sales to $1.14 billion. The impact of divestitures resulted in a 20 basis point pressure on reported sales. Earnings rose by a modest 2.5% for margins of 21.2% of sales.

Reiterating The 2014 Outlook

3M reiterated its expectation to report earnings of $7.30 to $7.55 per share driven by organic local-currency sales growth of 3-6%.

The company sees full sales down by about a percent due to foreign currency impacts, which are affecting revenues more so than earnings. This is in sharp contrast to the long-term targets for revenue growth of 4 to 6%.

Valuing 3M

By the end of the quarter, 3M held little over $4.2 billion in cash and equivalents while operating with nearly $7.0 billion in total debt. The net debt position of $2.8 billion is very much manageable but compares to a modest net cash position reported last year following sizable share repurchases over the past year.

With 665 million shares outstanding and shares trading at around $145 per share, equity in 3M is valued at roughly $96 billion. Given the projection for sales of around $31 billion and earnings of close to $5 billion, equity is valued at little over 3 times sales and roughly 19 times earnings.

Steady And Predictable Grower

Over the past decade, 3M has steadily and very profitably grown its business. Revenues have risen by a cumulative 50% from roughly $20 billion in 2004 to $31 billion by now. Total earnings rose by roughly 75% as net margins expanded to roughly 16% on an after-tax basis, which is very impressive.

Investors saw more earnings growth as the company retired roughly one in every six shares outstanding over this time period.

Final Takeaway

Investors hardly reacted to the earnings report, which did not contain any big surprises. Instead they focus on the long-term plan as laid out by CEO Thulin, which has focused on organic growth, R&D investments, international growth and a further increase of already fat operating margins.

Under terms of the plan, 3M is supposed to grow sales from $31 billion in 2013 by 4-6% per annum till 2017. This should result into sales of $37-$38 billion down the road. The problem is however that the first year into the plan, 3M is now forecasting annual sales to actually drop by a percent on adverse currency movements. The good thing is that the company reiterates its earnings growth guidance for 9-11% growth in EPS. This should result in earnings per share of about $11 by 2017.

Back at the start of the month, I last took a look at 3M's prospects following an upgrade from analysts at Argus. Based on the 2017 roadmap, shares trade at 13-14 times earnings projected 3-4 years down the road.

I noted that if the company executes and the economy continues to move steadily and grow, the company will grow into the valuation and show healthy returns. Yet there are risks if the economy takes a turn for the worse. I am willing to pay about 17-18 times earnings or at around $125-$130 per share which is a valuation at par with the wider stock market. The margin of safety at these levels results from healthy organic growth, strong margins and cash flow generation.

In the meantime investors receive a fair 2.4% dividend yield combined with a solid pace of share repurchases. For now I am holding off pulling the trigger despite solid results, awaiting a potential more interesting entry point.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.