3M: High Time To Take Profits
3M is currently trading near its 52-week high; however, forecasts of slower organic growth and increasing pressure on margins do not warrant a P/E multiple of 18.7x
The 3M Company (MMM), originally known as the Minnesota Mining & Manufacturing Company, is an industrial conglomerate with products and businesses as diverse as the markets it operates in. The company prides itself on being a “Global Innovation Company”, claiming that it introduces new technologies and products to millions of consumers worldwide.
3M generated 65% of its income from outside the US in 2012, with the Asian market contributing the largest share. However, Latin America and Canada have been its fastest-growing markets over the last five years, with a CAGR* of 8.6%.
3M is classified as a diversified industrial conglomerate and it operates and competes in multiple industries with a number of smaller competitors. As a conglomerate, its closest competitors are General Electric Co. (GE) and Johnson & Johnson (JNJ).
The company operates in five major segments, serving retail consumers and various industries worldwide.
Its Consumer and Office segment manufactures some of the most widely-recognized home products and office supplies. The segment’s product lines include Scotchgard™, Post-it and Scotch Tape, among other household names. The Electronics and Energy segment manufactures communication technologies, designs electronics and provides alternative energy solutions.
The Healthcare segment develops health information and drug delivery systems, along with medical devices and components. In its Industrial and Transportation segment, the company manufactures various products for mining, oil and gas, transportation and numerous other industries. The Safety and Graphics segment provides personal, roadway and fire protection services, along with computer privacy, graphics and optical solutions systems.
The company restructured its divisions and segments in 2012 to better align itself with end user markets and to improve operating efficiencies. It reduced its divisions from six to five by consolidating some product offerings, and spread the remaining between existing product lines.
The Industrial and Transportation segment has been the primary growth driver for 3M over the last five years. The company’s newly-formed Safety and Graphics segment, on the other hand, was down 1.8% in 2012, after 3M merged its Safety and Security division with its Traffic Safety Systems segment.
3M’s results for the second quarter (2Q) of fiscal year 2013 (FY13) were largely in line with analyst estimates. The company reported a 3% increase in sales and an EPS of $1.71, versus consensus estimates of $1.70. However, 3M missed its EPS guidance for operating income, but a lower tax rate on its profits made up for it.
Its Safety and Graphics segment was down roughly 3% YoY, and 0.8% over the preceding quarter. It also experienced the largest contraction in margins. The company faced headwinds in its Electronics and Energy segment due to lower demand: organic sales were down 1.3% after adjusting for currency impact, but margins expanded almost 2.5% over the preceding quarter.
The Asia-Pacific region posted the highest quarter-over-quarter (QoQ) organic growth at 3.1%. Europe and the Middle East and Africa (EMEA) regions recorded their highest growth in eight quarters, with a 1.4% increase in organic revenues from 2QFY12. Organic revenues from the US were up 1% for the quarter.
In the announcement, the company reiterated its EPS guidance of $6.60-$6.85 for fiscal year 2013, and increased its share repurchase target from $1.5 billion to the $3.5-$4.5 billion range. The company anticipates a 29-29.5% tax rate, 0.5% lower than in 2012.
It should be kept in mind that 3M has either met or beaten its guidance in four out of the last five quarters.
Stock Price Drivers
The company is an early cycle play due to its exposure to industrials, transportation and other commercial businesses.
The stock has appreciated almost 100% over the last five years, compared to a 70% appreciation in the S&P 500 Index over the same period. Further growth in emerging markets, share buybacks, and consolidation and divestitures are expected to have a positive impact on the stock within the next year.
3M’s historical five-year average P/E is 14.5x; however, the stock is currently trading at 18.7 times its earnings.
The consensus EPS for 3M is $6.72 for FY13 and $7.45 for FY14, based on estimated sales of $30.9 and $32.5 billion respectively for the two years. The sell side estimates that revenues will increase by 1.2% in FY13 over the previous year, but that revenues will increase 5.2% in FY14 from FY13, and net income will rise by roughly 8.4%.
While the company’s revenues will continue to rise, organic growth is not expected to be more than 5%. Even though strategic opportunities for acquisitions will always exist, there are no specific targets for company for the near future. Furthermore, any further divestitures seem unlikely, given the recent consolidation within the company.
Growth in emerging markets could provide a boost to earnings; however, most indicators suggest slowing momentum in the Asia-Pacific region. Meanwhile, the tepid US economy is currently mired in uncertainty due to budget sequestration.
We believe the company will see modest growth in revenues, in line with 2013 levels. 3M’s five-year CAGR for the period ending FY12 was 3.43%, and we forecast revenues to grow at the same rate in FY14.
Based on our analysis and current macroeconomic trends, we believe that 3M will continue to face margin pressure well into 2014. The company has experienced relatively slow organic growth, and while certain regions may be growing, Europe is still struggling with record unemployment levels and a debt crunch.
Meanwhile, the US market is in trouble due to impending budgets cuts, and China is showing signs of an economic slowdown. The stock is trading near its 52-week high of $122, and we believe that this is a good time to take profits and consolidate some positions in the stock.
*Compound Annual Growth Rate
**For our investment analysis, we combined data for the old segments with data for product offerings under the new segments.