Over the past three years, the market has begun to recognize that 112-year-old 3M (MMM 1.34%) is more than just a boring dividend stock. On a regular basis, shares in this diversified manufacturer are leaping to new 52-week highs:
During this stretch, 3M has more than kept up with the Joneses, too: its three-year average return trumped the industry average by 3.4% and beat the S&P 500 by 4.2%.
How exactly does 3M stay ahead of the pack? Well, there are exactly three (surprised?) business drivers working in its favor. Let's look at how each can continue to propel the stock higher:
3M's plan to boost organic growth
In the years following the Great Recession, 3M found itself at a crossroads. Under the leadership of former CEO George Buckley, the company had developed a hearty appetite for buyouts. They weren't big acquisitions, mind you, but they also weren't bolstering growth by doing what 3M has always done best: inventing the future from within.
By 2011, Buckley's "bolt-on" acquisitions accounted for 47.1% of 3M's global sales growth, up from 6.1% in the year prior. In 2012, when Buckley handed over the reins to his successor, Inge Thulin, it was clear 3M aimed to put the brakes on its buying spree. Investors wanted to see an emphasis on organic growth, which would ultimately be more sustainable over the long run.
Fast-forward two years, and 3M appears to be on the right track. Organic revenue growth, which was a measly 2.6% in 2012, is slowly but surely moving upward.
|
2012 |
2013 |
Q1 2014 |
Q2 2014 | |
|---|---|---|---|---|
|
Organic growth |
2.6% |
3.4% |
4.6% |
4.8% |
Source: 3M 10-Qs and 10-Ks.
What's more, 3M's growth is well balanced. All five business units -- industrial, electronics and energy, safety and graphics, healthcare, and consumer -- delivered at least 4% organic growth in the latest quarter.
Looking ahead over the next four years, 3M's management wants to continue to focus on innovating from within: Thulin and company aim to deliver 4% to 6% organic revenue growth each year through 2017. Right now, 3M looks to be heading in the right direction. Ongoing increases in organic growth should bode well for the stock price.
3M's pricing power is only getting stronger
As I've pointed out before, 3M commands a premium on its products in a manufacturing industry known for mediocre pricing power.
How does it do it? First and foremost, 3M differentiates itself by manufacturing value-added materials, not commodities. Customers know a 3M product is going to perform better than a rival brand. Its Scotch tape will stick better; its Scotchgard products will repel more water.
Thus, customers will pay a premium for these products, and that price differential trickles down to 3M's profit margins. In recent years, 3M's operating margins have been steadily increasing, a sign of a strong brand and an efficient business:
|
2011 |
2012 |
2013 |
Q1 2014 |
Q2 2014 | |
|---|---|---|---|---|---|
|
Operating margin |
20.9% |
21.7% |
21.6% |
21.9% |
22.8% |
Source: Morningstar.
For perspective, 3M's operating margin in the second quarter was 53% higher than the overall industry average of 14.9%. In the manufacturing world, 3M is virtually unrivaled in this regard.
As investors look to the future, rising operating margins (without sacrificing research and development) paint a promising picture for this company. If margins rise, so will operating income growth. In recent years, operating income hovered around 5%, but it jumped 9.1% year on year in the latest quarter. Investors hope that's a sign of things to come.
If 3M boosts R&D, something is bound to stick
Even as 3M strives to become more efficient, it's reassuring to see a management team willing to spend on the area that matters most: research and development.
Historically, 3M's groundbreaking products have stemmed from internal tinkering by engineers. And, more often than not, a breakthrough in one area, say household adhesives, had uses in another industry such as autos or construction. There's no telling where the next "game-changing" innovation will come from, but 3M has a history of harnessing the brainpower of its top-notch workforce.
Here's how management sees R&D dollars trending with a view to 2017:
Source: 3M's presentation at Citi 2014 Industrials Conference.
For context, R&D as a percentage of sales has hovered around 5.5% for the last decade. A break from the status quo could translate to a breakout product for the company.
Looking down the road, an increased emphasis on innovation could pay off handsomely for long-term investors.
The takeaway for investors
What's great about 3M is its willingness to take a risk to uncover the "next big thing" in materials technology. It could be related to natural gas transport (3M has teamed up with Chesapeake Energy on fuel tanks), touchscreen technology, or something completely unexpected. Regardless, the company's innovative culture is a unique asset few competitors have replicated.
By investing in that culture, 3M can spark innovation from within, boost organic growth, and enhance its bottom line. In the long run, this virtuous cycle will continue to provide market-beating returns for shareholders.
