The Long Case For 3M: High Margins, Low Leverage, Focus On Innovation

| About: 3M Company (MMM)
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3M (NYSE:MMM) is one of the biggest US industrial conglomerates, which has been growing dividends over the last 54 years. The company has the reputation of focusing on innovation and coming out with creative new products. The company has come out with a new 5 year strategy, to increase its R&D spending and reduce costs. The company is aiming for ~10% earnings growth over the next 5 years, with revenue growth of ~5% each year. What is interesting was that the management committed to 100% free cash flow conversion. The company is already investing in R&D with plans to open a new R&D lab at its HQ and hiring 700 scientists to run the new lab. The company is also looking at inorganic growth opportunities, having already bought ceramic maker Ceradyne in 2012.

What we like about 3M

  1. High Margins - 3M is different from other industrial companies as it has higher margins and return ratios. The company does not operate in capital intensive sectors which helps it return better margins. The company has maintained an operating margin of roughly 20% and a net margin of approximately 15% in the last decade. This is higher than other diversified industrial conglomerates which have a net margin of ~10%. The ROE of 25-30% is also on the higher side.
  2. History of Growing Dividends - 3M has been growing dividends every year for the last 54 years, which makes it a solid candidate for every dividend investor's portfolio. 3M increased its dividends even during the Lehman crisis, when many other companies like GE (NYSE:GE) were forced to slash dividends. The company has doubled its dividends during the last 10 years and currently gives an annual dividend of $2.36. The current dividend yield is ~2%.
  3. Innovation Focus - 3M is known as the company with a reputation of focusing on R&D. The company has invented revolutionary new products like Post-it notes and Scotch Tape. The company spends around ~5% of its revenues on R&D which it has committed to increase to 6% over the next 5 years. We can think of no big industrial company which gives so much attention to research.
  4. Meeting 2012 Guidance despite Slowing Economy - The Company has reaffirmed its 2012 guidance of $6.27-$6.35 in EPS and expects 6-10% growth in 2013. Despite the economic slowdown, the company has not cut its growth forecast. This is reassuring as we are leery of buying industrial companies due to their strong negative linkages to slowing economic growth.
  5. 2/3 Revenues from International Markets - 3M has a strong international presence, with almost 2/3rd of its revenues coming from international markets and half of those revenues coming from emerging markets. The strong international diversification helps the company avoid any country specific problems and gives investors a safe way to invest in emerging market growth.
  6. Low Leverage - Unlike other industrial companies such as GE , 3M operates with very little leverage and has only got $1.4 billion in total net debt. This makes the company a much safer holding during downturns. When other industrial companies crashed by 60-70% during the Lehman crisis, 3M stock remained relatively stable.

3M Risks

  1. Law of Large Numbers - 3M is one of the biggest industrial companies in the world which makes rapid growth impossible. The company will grow steadily without making any huge waves. The company is expected to grow at earnings around 8-10% in the long term, which means that investors can expect the same kind of returns.
  2. Stock Performance - 3M is trading near its all time high stock price of ~$99, climbing almost 15% from its recent low of $87 reached in November 2012. Unlike other industrial stocks, 3M is not too volatile and has traded in a relatively narrow range of $82-$99, in the last one year. The stock has given a good solid return of 18%, in the last one year and 31% over the last 5 years. The stock has outperformed the S&P by ~20% during the last 5 year period. The stock had fallen by almost 45% during the Lehman crisis but has recovered most of those losses.
  3. Valuation factors in 3M Advantages - 3M trades at a premium over its peers because of its higher margins and stable growth rates. The stock trades at a P/S of 2.4x and at a P/B of 3.9x, compared to the industry average of 1.4x and 2.6x respectively. The company's current P/E of 15x, is at a discount to that of the industry average of 18x.


3M is a solid long term investment for people looking to invest for ~10% return with low volatility. 3M has a long history of growing dividends and managed to grow dividends even during the Lehman crisis. The company's topline growth has slowed down due to its large size, however the management has committed to a ~10% earnings growth with 100% FCF conversion. 3m has a rock solid balance sheet which means that they can be more aggressive with acquisitions. The company has set aside $1 billion for inorganic opportunities in 2013. We think that company might want to be a bit more aggressive in its M&A strategy. We don't expect 3M to give superlative returns but the stock is attractive for a long term dividend investor. We would look to buy 3M during dips, as the stock is currently trading near its all time peak.

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.