3M – Firing on All Cylinders

3mNot every Wall Street analyst has a buy recommendation on 3M (NYSE: MMM) – in fact, only about a third do. So, I keep looking for a reason not to buy it and I can’t find one.  This $31 billion global industrial conglomerate headquartered in the heartland (near St. Paul, Minnesota) has long been a winner for investors, and to me looks like it’s just going to keep on being one.

You might only know 3M from its everyday consumer products, like Scotch tape, Post-It Notes or   sandpaper. But it’s a whole lot more than that. In fact, it makes more than 50,000 products, most of which it sells to other businesses.  It operates in five segments:  Industrial (34% of 2013 revenues and 32% of operating profits); Safety & Graphics (18% and 18%); Healthcare (17% and 24%); Electronics & Energy (17% and13%), and Consumer (14% and 13%).

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Its products range from adhesives and abrasives to workplace safety gear, laminates, dental products, electronic parts and materials, medical products, car-care products, electronic circuits and optical films. It makes the reflective materials that make highway signs visible at night, and computer touch screen systems.  It makes filters and anti-corrosion coatings for the oil field and a high-tech cooling fluid for the computers to make microchips, and computer touch-screen systems.

The driving force for 3M’s long history of growth has been technological innovation.  It employs thousands of researchers and spends around 6% of its revenues every year to come up with new technology and products.  Earlier this year, it received approval for 52 U.S. patents, bringing its lifetime total to 100,000.  And when the company doesn’t create its own new products, it makes smart acquisitions.

In 2012, senior management announced five-year financial goals, and so far the company is on track for achieving all of them. They include, annual growth in earnings per share of 9%-11% per-year; annual growth in organic sales of 4%-6%; sales growth; around 20% return on investment, and approximately 100% free cash flow conversions (that is, the percentage of earnings before interest and taxes becomes free cash) – all above recent trends for the S&P 500.

3M has a long history of rewarding investors.  It’s one of 54 U.S. companies that have increased dividends over the past 25 years, and for the same period of time it’s outperformed the S&P 500 on a total return basis, 12.39% to 7.69%.  With varying spreads, the comparison remains the same over shorter five-year periods.  Year to date, the stock is lagging the market, but it creamed it last year (50.36% to 28.73%), and over the last 12 months it has beaten the market by almost 6 and half points, 21.24% to 14.82%.

The stock closed today at $140.11, with a dividend yield of 2.44%. At that price, it traded at 20.3 times trailing EPS, compared to the S&P 500 average PE of 18.3, and the stock’s 13-year median PE of16.2.  That valuation sounds a little rich, until you factor in a couple things. First, the Wall Street consensus is that 3M earnings per share will grow 12% per year over the next five years, a point better than the top of management’s goal range.  Second, since 2000, the median annual growth in 3M’s dividend was more than 5% a year, and there’s little reason to believe the company will deviate from that record in the future.

Earlier this year, 3M raised its quarterly dividend by 39%, from 63.5 cents to 88.5 cents, following its announcement to do so last December. At the same time, the company announced a huge increase in its stock buyback program through 2017, upping its estimate of buybacks from a range of $7.5 billion-$15 billion to a range of $17 billion to $22 billion. It also announced it will devote another $5 billion to $10 billion through 2017 on acquisitions.

Wall Street’s one-year price target for 3M is $153 and change.  I think that’s reasonable, if current the current PE holds at 20.31. And if it holds for five years, at the estimated earnings growth rate you could see the stock breaking $200 a share by 2018 and approach $250 a share in 2019.  With dividends growing 5% a year and being reinvested, in this scenario the stock throws off an annual average return north of 20%.

I did a more conservative projection, based on the stocks PE contracting by one point a year, until it reaches its median of 16.20 since the year 2000.  That shows a more modest annual average return of between 14% and 15% year.  That’s plenty good for any long-term investor.

Could we all be wrong? Sure. 3M faces plenty of risks. But then I look at one key figure:  between 2003 and 2013, 3M’s sales have grown 1.5 times the Global Insight Worldwide Industrial Production Index.  However the global economy does, 3M has proven it knows how to stay well ahead of the pack.

About Lawrence Meyers
 lawrence meyersLarry is regarded as one of the nation’s experts on alternative consumer finance. He consults for hedge funds and private equity via his Council Member status at Gerson Lehman Group, and as a member of Coleman Research Group’s Executive Forum. He also consults for Credit Access Businesses and Credit Services Organizations in Texas. His Op-Eds and Letters to the Editor have appeared in over two dozen major newspapers. He also brokers financing, strategic investments, and distressed asset purchases between private equity firms and businesses of all stripes. You can reach him at pdlcapital66@gmail.com.

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Lawrence Meyers

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