3M - Part 1

What makes this familiar company special

Apr 23, 2021

A reader has reached out and asked for an analysis of 3M, and the reasons why i own it, so let’s have a look at this Dividend King.

What is 3M?

As per their 10-K report, 3M is:

3M is a multinational conglomerate that has operated since 1902 when it was known as Minnesota Mining and Manufacturing. The company is well-known for its research and development laboratory, and the firm leverages its science and technology across multiple product categories. As of 2019, 3M is organized into four business segments: safety and industrial, transportation and electronics, healthcare, and consumer. About 60% of the company’s revenue comes from outside the United States, with the safety and industrial segment constituting most of the firm’s net sales. Many of the company’s 55,000-plus products touch and concern a variety of consumers and end markets.

In other words, 3M is a large industrial multinational conglomerate that develops and manufactures many products in different segments of business.

Although it is an American company, most of its revenue and employees are located throughout the world, particularly in Asia and Europe.

Many of the products we use on a day to day basis were developed by 3M, and manufactured by them as well. From Duct Tape and Post-its to the masks we wear on a daily basis thanks to the pandemic, 3Ms products are a part of our lives.

They make money by selling those products to businesses and consumers.

Strengths and Weaknesses

Every company has some core competences, and some weaknesses.

Some of these risks and weaknesses are inherent to the company itself, and some are related to the area of business and regulatory environment in which the company operates.

3M is no different, so lets go over some of its core strengths and some of its key weaknesses.

Strengths:

Diversified product line with over 60 thousand different products
Operates worldwide
Unusually high margins in traditionally low margin businesses
Long standing commitment to return value to Shareholders

Weaknesses:

Regulatory actions due to environmental/health concerns with certain products
Outstanding Pension and other post-retirement plans
Payout ratio does not have a lot of room to grow sustainably
Stagnating revenue and a mature market leaves little room for further expansion

The business itself is understandable, however the stagnating revenue and mature market in which it operates is concerning.

Lack of opportunities for expansion means both earnings and revenue will likely not outperform in the future. This is a red flag most of the time, and we will have to see if there are some major strengths that balance this out.

The outstanding regulatory actions and the drag that the Pension and other post retirement plans cause on the company is also concerning.

That being said 3M is a very large company that operates all over the world, their products are useful and developing, making and selling them is generally a profitable operation.

If 3M carries on the path that it is on, even without further growth, it may still be worthwhile to own them at the right price.

Let’s have a look at their numbers over the past 10 years.

Income Statement

Here we are:

That’s a lot of data!

The vast majority of companies live and die on their earnings, so let’s have a look at the earnings per share chart:

It looks pretty good, with steady and consistent improvements in the earnings per share… But is it?

If we do the math we see that the CAGR is actually pretty bad, only 5.09% per year.

Given that we have been in a long drawn out bull market this 5.09% increase is pretty bad…

Have they been issuing shares, therefore depressing the stock price?

On the contrary! Their share count has been going down throughout , indicating that they have been doing share buybacks.

This means that the 5.09% Earnings Per Share growth is the result of not just earnings growth, but also share count reduction.

If we check the total earnings, we see:

It doesn’t look good.

The total earnings have been pretty flat, which isn’t great. That being said, they have been consistently profitable, so its not a total loss.

Their profit margins have also been steady at around 21% throughout, which tells me that they might have a Durable Competitive Advantage.

It hasn’t been enough to make them outperform the market in the past couple of years, but that doesn’t mean it’s not a key asset.

Balance Sheet

The balance sheet itself is not particularly outstanding, but we can draw a few conclusions from it:

3M is not an asset play and its equity is mostly comprised of Goodwill
Long term debt has been increasing and may become a problem in the future
There are no major short term dangers
3M has been buying back shares, while still reinvesting some of its earnings

Let’s break this down on each of these points:

3M is not an asset play

This is pretty simple to see, its total shareholders equity is lower than the goodwill of the company, which means that if the company shuts down tomorrow we will for the most part be left high and dry.

If you’ll recall, Goodwill is the difference between what the company paid to acquire a business as a whole versus the actual dollar value of that businesses equity.

In general it accrues when a company buys another for more than its book value.

In this case almost 30% of 3Ms assets is Goodwill, which is a hard pill to swallow, there may be some hidden asset being carried at purchase value that is now worth significantly more, but given the scale of the company I doubt it.

If we own 3M we will own it for its earnings power, rather than its assets.

Long Term debt has been increasing

Exactly what it says on the tin, long debt has been consistently increasing in the past ten years.

Perhaps this is a part of its strategy, or perhaps it’s indicative of an ongoing problem.

The company has been profitable, and consistently returned those profits to shareholders, so its hard to say if the increased debt is the result of a change in strategy, or of poor management.

We will discuss this in greater detail when we talk about the companies story.

There are not major short term dangers

Their current assets are reasonably strong, and they will most likely be able to pay off the liabilities they have for the upcoming year.

They have enough cash and inventory that they are not at risk of going bankrupt any time soon.

This gives us plenty of slack, and notice in case of a major issue with the company. It also gives 3M enough time to turn things around if something bad happens.

3M has been buying back shares

Not only are they an aristocrat, but they have been buying back shares at a steady pace, as seen by the “Treasury Stock at cost” section.

Overall that’s close to 20 Billion dollars worth of value they have returned to shareholders, which is more than the long term debt they have taken on.

This is a positive sign in regards to the debt, because it indicates that they will be able to pay down that debt if they choose to focus on it.

Is 3M a good company to own?

This is a difficult question to answer, especially when we compare it with the company we previously looked at, AFLAC.

Clearly there isn’t really anything particularly interesting in the balance sheet that we are buying. Make no mistake, 3Ms factories, infrastructure, logistics are all world class, and certainly valuable, but those don’t show up on the balance sheet, and if the company were to shut down they wouldn’t put a lot of cash in your pocket.

Ultimately we would be buying 3M for its earnings capability, which is solid. 21% profit margins are very good, and a clear indicator that 3M is a solid business with a durable competitive advantage.

The lack of growth there is concerning, but we have to take into context the industry that its in. It’s a mature industry and 3M has a mature and extensive business already. While it may be possible for them to tap into as of yet untapped markets, it is doubtful that their growth rate will be significant in the future…

Or will it?

Are the earnings being sold at a fair price?

Can we expect 3M to be more valuable than the market is currently valuing it at?

At first glance I would say no. 3M is likely fairly valued, and no significant margin of safety exists at this price $200.

But lets come back next week, and calculate a more accurate and in depth valuation for this business.

Let me know what you think!

And as always, if you have any questions or comments, shoot them on Twitter @TiagoDias_VC or down below!

I’ll see you next time!