3M Company (NYSE:MMM)

3M is a diversified industrial conglomerate which manufactures over 55000 products available for sale in over 200 countries. The company’s major products include adhesives, laminates, fire protection products, medical and surgical supplies, dental products, office supplies, and car care products. Some of the company’s most recognizable brands include Scotch Tape, Post-It notes, ACE bandages and Thinsulate insulation products.

Since the 3Q of 2011, the company’s share price has increased about 128%, including a sharp increase in the final quarter of 2014. Where does this leave investors in the company and those looking to invest?

The Vuru grade for the company is a strong sign for investors despite low growth and stability prices. This is on the basis of a strong dividend and economic moat.

2015 Management Expectations

EPS Guidance

$8.00-$8.30, +6% y/y

Shares Outstanding

Expected reduction of 3-4%

Margins

Expected to rise 50 base points

Outlook

The company has two main catalysts for its upward rise in guidance for EPS in 2015. They are growth in emerging markets and a lowered cost base. The first catalyst will be a boost for the company’s top line, while the second will help the bottom.

Growth in emerging markets will be mainly from rapidly developing economies in China and India. As the middle class grows in these countries and disposable income increases, there will be substantial growth in demand for consumer goods and household products. As well, industrialization will drive growth and demand for office supplies and specialty chemicals. Additionally, more readily available health care is expected and the medical device segment will continue to see upward growth. These emerging markets now represent 30% of the company’s sales.

The low oil price point will significantly help the company in the coming year. With Brent Crude about half of the price it was earlier in 2014, shipping and material costs for the company will be significantly reduced. This further benefits the company as many consumers are left with more disposable income in their pockets to be spending on the company’s many products.

One concern for the company does come in the form of product lifecycles. Given some of the competitive markets in which 3M competes in, (particularly technology and healthcare) product life cycles are always a large focus for management. Constant innovation is always required to remain at the forefront of the industry and will require significant amounts of research and development expenditure.

Economic Moat Trend

The essence of 3M’s very differentiated approach to creating value is to use its higher R&D to fund more rapid and significant new products to drive organic growth, aided by the company’s new ERP system to enable real-time optimized pricing, market intelligence and logistics. This is done to generate a more uniform and consistent margin and growth across all of the company’s business units. This is very well illustrated in the chart below. The company’s net profit margin 13% and 17% since 2004 and appears to have an upward trend in recent years.

The company uses it notably superior operating and go-to-market analytics to support and increase in its leverage and thereby drive its ROE to the mid-30%. The distinguishing characteristic of 3M’s ability to create incremental shareholders value is its ability to sustainable life ROE by having a committed to reducing the company’s share count by 10%-12% in 3 years.

Major Risks

  1. Slower than expected rate of new product development resulting in market share loss
  2. Weaker global economic growth (particularly in emerging markets) or a reduction discretionary income
  3. Issues with integrating recent acquisitions and an inability to accelerate top line growth via recent marketing and R&D investments

Investment Rationale

The company’s main focus is on increasing its global footprint and this should continue to ensure that the company is able to consistently execute on virtually all operating metrics and is able to achieve double digit EPS growth in an uncertain global economy.

3M currently trades at $159.51 (Jan 07, P/E 21.90) with potential for investors in the near and long-term. This potential is on the basis on being able to create growth in volatile emerging economies, reduction in the company cost base and a strong track record for innovation.

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