3M Company's R&D Bet Paying Off As Organic Growth Drives Results

3M's second quarter earnings were up across the board as a bet on R&D is beginning to pay off.

Jul 24, 2014 at 2:23PM

3M's (NYSE:MMM) investment in R&D is paying off and second-quarter results showed the strength of following such a strategy. Sales were up 4.9% in the second quarter to $8.1 billion, almost entirely because of organic growth, and net income was up 5.8% to $1.27 billion, or $1.94 per share.

What's unusual about the numbers is that growth was spread almost evenly across industries and regions. Healthcare, industrials, and safety and graphics all grew 5%, while electronics and energy and consumer grew 6% and 4%, respectively.

Regionally, growth was highest in Asia-Pacific at 7%, but Europe-Middle East-Africa and the U.S. both grew 5% and Latin America-Canada grew 3%.

Mmm Image Flickr

Scotch Tape has long been one of 3M's most successful products and it came out of 3M's lab. Photo: The Motley Fool.

Bet on R&D paying off
When Inge Thulin took over as CEO from George Buckley he renewed 3M's focus on R&D and deemphasized acquisitions. This quarter is a great example of the results of that decision with organic growth of 4.8% and total growth of 4.9%. Acquisitions played almost no role in the quarter at all. The R&D focus has also resulted in across the board gains for the company's target industries and regions. 

It may seem like a subtle change because R&D spending last quarter was 5.5% of sales versus 5.2% three years ago, but R&D spending is up 28% over that time and those incremental dollars can be put into growth. 

In 3M's labs there's invariably a certain amount of money that needs to be spent on R&D to keep up with regulations, update products, and find cost savings. This money has to be spent just to keep 3M going. When you add even 0.3% of sales to the R&D budget those dollars can then be spent on growth, something we're seeing today. 

Mmm Ocello Image Flickr

3M's product line extends into sponges with the O-Cel_O brand. Photo: The Motley Fool.

3M bets on Japan
One of the big moves 3M made recently was acquiring the 25% of 3M Sumitomo -- its Japanese subsidiary -- that it didn't already own. The acquisition should close late this quarter and will cost $885 million.

The price values the enterprise at 1.1 times sales and 7.0 times EBITDA, which all things considered is a decent value for 3M. For perspective, 3M's own stock is worth 3.2 times revenue and 12 times EBITDA.

Management expects the acquisition to be accretive this year with about an $0.08 per share impact in year one. If true, it'll be a nice incremental add for 3M.

Returning cash to shareholders
What most investors are interested with 3M is the dividend payout and share buybacks. On that front, 3M continues to be shareholder friendly.

During the second quarter, 3M bought back $1.4 billion in shares and paid $556 million in dividends. Given the $1.27 billion in earnings and the fact that 3M converts 90%-100% of its earnings into cash that's a comfortable payout ratio of 44% in the quarter.

3M's dividend yield of 2.4% isn't the best in the market but with business going well across the board and payouts at a comfortable level it's a dividend I feel incredibly comfortable owning. Remember that 3M has paid a dividend for 97 straight years and increased that dividend for 56 straight years. If you're looking for a consistent payout this is it, especially now that business operations are hitting on all cylinders.

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Travis Hoium manages an account that owns shares of 3M. The Motley Fool recommends 3M. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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