Oak Value Fund: The Long Case For 3M

| About: 3M Company (MMM)

Oak Value FundExcerpt from the Q1 2007 letter to shareholders from David R. Carr Jr. and Larry Coats Jr., managers of the Oak Value Fund:

Given the extent to which we talk and write about our quest to find sustain-ably advantaged businesses, we believe this quarter provides us with a great opportunity to point out that “we put our money where our mouth is”. That’s because we believe the three stocks we bought were each good businesses as evidenced by their underlying attractive economics. The additions we made were Aon, Microsoft, and 3M. Each has produced returns on invested capital that are either already high or improving dramatically, each is capable of serving an increasingly global client base, each has relatively new yet highly respected management teams, and each is optimizing its balance sheet. In short, we believe that each of these high quality businesses represents a very good investment, at the price we paid...

3M (NYSE:MMM) - The other high quality business we bought this quarter was 3M. Like Aon and Microsoft, the company earns remarkably high returns on its invested capital given its large size. 3M is a global leader in manufacturing and marketing technology-oriented products and services. The Minneapolis-based company serves many verticals and operates several different segments: industrial and transportation; health care; display and graphics; consumer and office; safety, security and protection services; and electro and communications.

Over the years, 3M developed a reputation for being a high quality company with great brands that earned ever-improving margins albeit with somewhat average growth characteristics. We believe that the company has recently entered a new phase, one that will be characterized by higher growth. Moreover, we believe ample opportunities exist for the company to achieve this accelerated growth without sacrificing margin. To the contrary, margins in many businesses will expand over time. 3M is at the beginning of a multi-year process of transforming its manufacturing footprint from being US-centric to being international-centric. In 2006, about 60% of the company’s revenues were international while only 40% of its manufacturing was international. 3M intends to increase its overseas manufacturing capacity significantly. Moreover, 3M anticipates that its international revenues are expected to be close to 70% of total revenues within five years. We think this will create significant value for the company’s shareholders.

While 3M is certainly not a company that is going to fly beneath anybody’s radar, we note that some of the same winds of change that are blowing through companies like Microsoft are blowing in Minnesota too. We believe that 3M is in the early stages of a multi-year transformation that will yield accelerated growth amid high ROIC (Return on Invested Capital) and operating margins. CEO George Buckley, who joined the firm in late 2005, is an ardent believer in EVA (Economic Value Added ) and in the importance of ROIC in value creation, and is the primary architect of the company’s renewed focus on growth and its commitment to investing for the future, particularly in high-growth markets overseas. We had the good fortune to be familiar with Buckley’s work before he joined 3M, and we are glad to be investing in the company as it enters what we believe will be a phase of renewed growth and profitability...

A key component of our “good businesses with good management at attractive prices” philosophy is that of valuation. As a reminder, our goal is to invest in advantaged businesses when Mr. Market offers them up to us at prices that we believe offer an attractive margin of safety. We typically draw this line in the sand at a 30-35% discount to our estimate of the company’s intrinsic value. In our estimation, the allocation of the Fund’s collective capital to these businesses during the quarter clearly met this threshold.

See also: other fresh money buys from the Oak Value fund here and here.