3M: International Exposure at an Attractive Price

I initiated a position in 3M (MMM), a global leader in innovative products ranging from LCD screen films to scotch tape, roofing granules, water filtration, health care, you name it. Everyone knows 3M - it has fantastic brand equity. More than 60% of 3M's sales are overseas, and it does business in over 200 countries.

I first bought 3M in some of my portfolios a little more than a year ago, and it has since nearly round-tripped to 95 and back below 80. The company recently reported a good quarter and raised guidance, yet the stock got slammed.

The reason, as it was a year ago, was fluctuations in the LCD film business. 3M makes high-end coatings for LCD TV's and monitors that increase brightness and evenness of illumination. This business has provided a lot of growth for 3M over the past few years, but it is inherently volatile. They noted on the call that they would be lowering prices of some films in response to competitive pressures.

I think this is a transient issue, as it was a year ago. Away from this business line, the weak dollar is helping 3M's overseas sales, and many business lines continue to be strong. That's the key to 3M's strategy. It has a broad portfolio of businesses across which it leverages its unmatched R&D capabilities. It continues to invest in the future through this healthy R&D spending and through new manufacturing capacity near it's overseas end markets.

Even though 3M spends 6-7% of revenue on R&D, it still generates attractive operating margins of >20% and free cash typically well over 10% of revenues and greater than reported net income. ROIC is typically at least in the high teens. Margins are increasing as the company experiences greater economies of scale.

3M has historically traded at >20x earnings, yet you can by it now for < 15x next years earnings. I expect that over time 3M can grow earnings and free cash at a low teens rate on sales growth of mid-high single digits. Add to this potential multiple expansion and share buybacks (the company has bought back nearly 10% of it's shares in the last 3 years and carries very little debt) and we could see mid-teens+ returns. My estimate of intrinsic value is about 30% above current prices.

Disclosure: Long MMM