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Behind 3M's Shockingly Good Quarter

By Travis Hoium - Oct 25, 2017 at 9:47AM

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Smartphones and electric vehicles could power solid growth for the highly diversified manufacturer.

3M Co. (MMM -0.53%) isn't known as a growth company but it has spent the last few years investing in projects it hoped would pay off with greater sales in the long term. OLED technology, brightness-enhancing films for smartphones, and graphics products are just a few of the company's key products, and based on its third-quarter results, these investments appear to be paying off. 

Not only did 3M grow revenue and earnings at 6% and 8.4% respectively, it was organic growth that drove the results, not currency fluctuations or acquisitions. If the trend continues, the stock could be a great long-term investment. 

Smartphone looking at a circuit board.

Smartphones and other electronics are becoming a big part of 3M's business. Image source: Getty Images.

What changed last quarter

The headline numbers of 6% revenue growth to $8.2 billion and 8.4% net income growth to $1.43 billion, or $2.33 per share were what caught investors' eyes on Tuesday. It also didn't hurt that management said organic local currency growth would be 4% to 5%, raising the lower end of the range by a full percentage point, and increased its EPS guidance from a range of $8.80 to $9.05 to a new range of $9.00 to $9.10. 

Beneath the headlines, 3M's strongest segment was electronics and energy, which delivered 13.1% growth, or 13.2% on a local currency basis, to $1.4 billion. Sales in the Asia Pacific region were up 20%, driven by sales to manufacturers of electronic devices and batteries for electric vehicles. 3M has long been a key component supplier to the electronics industry, making films used in most smartphones, among other critical components. But because it's riding on the growth of its partner companies, its products don't generally get much attention from the media or investors. 

What's interesting is that the 3M products most people do know aren't doing as well. Consumer sales were only up 2.2%, 1.9% on an organic local currency basis, to $1.2 billion. Sales grew 7% in Asia Pacific, but were only up 3% in Latin American and 1% in the U.S., while falling 2% in Europe, the Middle East, and Africa. 

3M is still primarily a dividend stock

3M shareholders should see the Q3 growth as a sign that the company's dividend is safe for the long term. It spent $380 million in the quarter buying back shares, and $701 million on its dividend -- which it has been paying for 100 straight years. But its payout ratio, ( the percentage of net income paid to investors in dividends) has climbed since 2014 to over 50%, a level that could make investors nervous if earnings were to flatline. 

MMM Payout Ratio (TTM) Chart

MMM Payout Ratio (TTM) data by YCharts

Organic growth should ensure that the payout ratio falls to a more sustainable level, while still enabling dividend growth long-term. 

Will 3M's growth continue? 

3M's organic local currency growth of 6.6% in the third quarter was solid, but it likely won't be a new normal for the company. New smartphone manufacturing is being ramped up and battery manufacturing is being built at a rapid rate in China right now. Those were major tailwinds that won't last forever for 3M. 

With that said, it does look like 3M's financial performance is on much more solid footing than it was a few years ago. Outside of consumer products, organic growth exceeded 6% for the company's business units, and it appears well positioned to ride sales of a new wave of electronic products that will likely grow for the next decade. That growth should keep its dividend safe, which is the best reason to own 3M stock long term. 

Travis Hoium owns shares of 3M. The Motley Fool recommends 3M. The Motley Fool has a disclosure policy.

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