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Using a Value Line Report: 3M - Spotlight on Diversification
Just over a century since it started as a failed corundum mining venture in Two Harbors, Minnesota, Minnesota Mining and Manufacturing, now 3M Company (MMM - Free 3M Stock Report), has become the epitome of the diversified industrial conglomerate. The company has a wide spectrum of industrial exposure through its six primary business segments: Industrial and Transportation, Health Care, Consumer and Office, Display and Graphics, and Electro and Communications. While it is not the only well-run diversified industrial outfit, it is arguably the most operationally efficient, rivaled only by another iconic industry counterpart, General Electric (GE - Free General Electric Stock Report). Moreover, during a period when industrial manufacturing has been tepid at best in the years following the last recession, 3M has remained an industry stalwart with regard to revenue and profit growth.
A look at the historical financial data in the Statistical Array reveals that the company has grown profits in eight of the past ten years, with the only slippage occurring during the recessionary period between 2008 and 2009. And even then, 3M managed to stabilize its margins fairly quickly. Although it has faced some challenges bringing those margins back above pre-recessionary levels, incremental gains are likely to accelerate once the economy picks up momentum. Indeed, analyst Erik Antonson notes in the Analyst Commentary section that, “We expect a considerable amount of effort to go into boosting gross and EBITDA margins once the economy is back on a more-solid footing.” While it is quite commonplace for industrials to be pegged to the broader economy’s performance, we believe that of the diversified companies, 3M stands out from an operational viewpoint.
There are several factors that support this notion. The primary being the Financial Strength and investor-friendly use of free cash flow. 3M’s superlative marks for Financial Strength (A++: Highest), and Safety (this stock has been ranked 1 since July of 1990) place it in the highest order of sound investments. Meanwhile, its consistent efforts to enhance shareholder value by raising its dividend every year for well over a decade, coupled with its fairly aggressive stock-buyback program, should offer further appeal.
Although the company’s financial merits are commendable to say the least, another draw here is the diversified model and its specific concentrations. For example, 3M’s second largest business segment, Health Care, offers an investor meaningful exposure to the healthcare arena without having to purchase a pure-play healthcare stock, which is often among the riskier of equities. In addition, its stock performance is fairly competitive with larger healthcare specific names, such as Covidien (COV).
Another important factor to consider is the company’s history of innovation and recent heavy investments in research and development, with the aim of further diversifying its already wide spectrum of products. Indeed, rollouts have been gradually growing in share of sales. This suggests that, while it is widely touted as a steadfast but slow-moving vehicle, 3M’s emphasis on reestablishing its reputation as a cutting edge industrial innovator, once rated alongside Apple (AAPL) and Google (GOOG) as one of the most innovative companies in the world, augurs well for profitability. Although these accolades were achieved many moons ago, a business of this scale with its level of financial flexibility arguably has the capability to compete on any level, assuming management is willing to spend the money to achieve set goals. Furthermore, 3M’s emphasis on using economies of scale to maximize efficiency provides a reasonable edge, as the company tends to set up shop for manufacturing its products in the locales where it intends to market those products. This is just one example of how 3M keeps its margins relatively high.
On the downside, however, the stock is somewhat fairly valued at present. MMM shares have been on a tear over the past two years, up almost 84% since October of 2011. Moreover, it recently hit a new all-time high of $126.38, lifting its P/E multiple to approximately 18x projected 12 months earnings. This valuation is somewhat rich in comparison to its averages over the past decade. Hence, a glance at the Ranks box displays that MMM is ranked 5 (Lowest) for Timeliness, which indicates that we expect the equity’s price performance to lag the broader market’s averages over the next six to twelve months. In addition, a look at the 3- to 5-year Projections reveals that the stock is already trading within our Target Price Range out to late decade, as well. This suggests that most of the revenue and earnings growth we envision over the next 3 to 5 years has already been discounted by the market.
Nonetheless, we believe that the fundamentals here may well call for a more contrarian perspective on these shares at the moment. In our view, MMM could well return to pre-recessionary P/E multiples, particularly when the global economy regains momentum. Indeed, the company’s broad geographic footprint offers substantial upside potential, especially as it continues to invest in new products and services, where it can capitalize on growth-oriented markets, particularly in emerging regions.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.