3M - Part 3

The story we're missing

We’ve been looking into 3M over the past couple of weeks as a possible investment. We’ve had a look at its past 10 years of business, and based on that data and comparisons with its competitors we now have a decent idea of how much the company is worth.

That being said, there are still some open questions which we will go over in this post.

The Questions We Need Answered

The past 10 years have brought about some changes in the way 3M does business, and so if we want to understand the story of this company we will need to have some of the questions we’ve seen answered.

To be more specific, we need the answers to the following questions:

1. Why has Revenue and Earnings stagnated over the past 10 years?

2. How concerning are the Pension and Regulatory actions that are risking the company?

3. Why has Long Term debt been increasing, particularly in the past 5 years?

4. Where will 3M go from here in terms of strategic priorities?

Once we have those answers, we will know what the story of this company will be, and will then be able to follow it along.

So lets answer them!

Why has Revenue and Earnings stagnated over the past 10 years?

If we have a look at the income overtime the first thing that we will see is that since 2017 3Ms income has dropped significantly.

Having read the managements comments in the 10-Ks of the years in question there were 2 main reasons for this stagnation:

1. Divestment of non-core assets and divisions

2. “Softness” in certain end markets, particularly China and the US

Overall I would say this is about as good as we can expect.

When it comes to the first reason, the divestment of non core assets, this is arguably a good thing. 3M is a large conglomerate, and large conglomerates by their very nature have a difficult time responding to changing market conditions.

By focusing on its core competences, and setting aside some non-core assets 3M will be able to become a leaner company with greater focus and growth on its key businesses.

The second reason on the other hand is almost entirely outside of 3Ms control, and has a lot more to do with the US-China trade war that began with US President Trumps election, than anything specific to 3M.

I suspect that now that there is a new US administration in charge, some of the most outward symptoms of this geopolitical game will be alleviated, and 3M can return to growth in China.

Even if the trade war continues, 3M has already began recovering its earnings growth capability, and I expect it will continue to do so in the future.

How concerning are the Pension and Regulatory actions that are risking the company?

Earlier we saw that there were some outstanding Pension liabilities in one of the risks outlined by the company in their 10-K, but how big of a risk is this really?

On a worldwide basis 3M’s pension and post-retirement plans were 87% funded at year end 2020 which is fairly good, however they do use an unusually high expected long-term rate of return (6.5%).

While this is compatible with a broad market index fund, it’s still a meaningful risk that might in the future require additional cash payments from 3M in order to fulfill their obligations.

But are the current cash payments unsustainable? At 100 million a year I would say 3M has the earnings power to sustain it without much issue.

On the bright side, their defined benefits plans have been closed to new entrants since 2009, which means we will not see any new liabilities there in the future.

The regulatory actions too are something that have been consistent throughout the past 10 years, and while only one large one is outstanding right now, more will likely continue to come about.

The cost there is more significant, and from past experience I think we can expect charges of around 1 billion dollars associated with it.

Thankfully the products in question are no longer sold, and so additional charges on that particular product line are unlikely.

All the same, 3M is constantly developing new products, which may have their own issues and regulatory concerns.

This is a problem, but ultimately a cost of doing business in the lines of business that 3M operates in.

It doesn’t appear that 3M is being irresponsible, so i would keep an eye on this sort of issues going forward, but i wouldn’t hold it against the company.

Why has long term debt been increasing?

To put it simply, the company has been restructuring over the past few years in order to focus on its core assets.

This restructuring has come with some costs, and also the divestiture of certain businesses, such as their abrasive glass products, or even their entire Communication Markets division.

This is reflective of a more long term industry wide trend where conglomerates are shedding their non-core holding, and refocusing their business.

In the future I expect this internal consolidation to slow down, and the associated costs to decrease.

Will we see 3M begin paying down its debt? Not in the next couple of years, but I expect that in 5 to 10 years we will begin seeing some meaningful steps being taken to reduce the debt burden.

Where will 3M go from here in terms of strategic priorities?

There are 3 key points that 3M will continue to prioritize:

• Product and Market Innovation

• Organizational Optimization

• Environmental Sustainability

All of these are good things that bode well for the company, and ones that I am confident they will succeed at.

3M has always been an innovative company that responds to market trends by developing and selling new products that provide value to its clients. Coming out of the pandemic 3M has an opportunity to bring its innovation to a rapidly changing economy.

When it comes to optimizing the way they do business, that too is a reasonable goal, and one that they have been succeeding at. For 2021 they are embarking on a series of actions across the company that will reduce operation costs by $250 to $300 million.

This, combined with the more nimble company that is emerging from the ongoing restructuring indicates that management is focused on keeping costs low, a necessity given the current inflation concerns at the moment.

Finally, when it comes to environmental sustainability, 3M has committed to cutting carbon emissions by 50% by 2030, 80% by 2040 and be fully carbon neutral by 2050.

Saving water too is a key concern of theirs, and they expect to achieve a 10% reduction in water use by the end of next year, and a 25% reduction by 2030.

These pro-environmental policies will pay dividends in the future, not just from lower resource usage costs, but by getting ahead of incoming environmental regulation 3M gains a competitive advantage versus its less environmentally conscious competitors.

The Verdict

We know what 3M is and does.

We know its course over the past 10 years.

We know where it will go in the future.

We know how owning it will benefit us.

We know (roughly) how much the company is worth.

So now we need to decide whether we will pull the trigger and invest in 3M.

The company is not at an attractive price at the moment, so the answer is NO.

That being said, 3M is a decent company that has been beaten down over the past 10 years, but is well positioned to recover in the next 5 years.

I will not sell my current shares because it is not wildly over valued, but I will not buy more at the current price.

Should the price per share go down to $150 I will seriously consider buying more.

You may have a different view, and if you do i would encourage you to comment down below, or tweet at me. I am always open to listening to other views.

I’ll see you next time!