3M (MMM 0.12%) carries a reputation for playing it a little too conservative and not offering the best performance early in a recovery. However, 3M's current management team seems to be moving more aggressively to reposition the company for more dynamic full-cycle results. Although it's not really a quarter-to-quarter type of company, 3M's underlying performance was better than the quarterly report results (and Wall Street's reaction to them) might otherwise suggest.
A respectable set of results
3M reported revenue growth of close to 3%, with organic growth closer to 5% on a 3.4% improvement in volume. The company's 1.2% pricing improvement was also more aggressive than the sub-0.5% price improvements seen by many of its peer conglomerates.
3M also showed some improvements in margins. Gross margin rose half a point, but the company gave some of that away through higher SG&A and R&D spending. Operating income rose 4%, leading to a 30bp improvement in operating margin.
Relatively good top-line growth, but paying for future growth today
Compared to its conglomerate peers, 3M's results were good. That 4.6% organic revenue growth number compares well to Ingersoll-Rand (up 3.6%), but General Electric wins this round with organic revenue growth in excess of 8% for the quarter.
The flip side is that 3M is spending on "productivity" and "strategic" investments that are intended to upgrade the company's full-cycle growth and earnings potential. The impact in this quarter was a 0.9% reduction to operating margin that reduced operating income growth by about half (from a prospective 8% growth rate to the reported 4% growth.)
As a result, 3M lagged it's peers in operating income growth, who were in the high single digits to low double teens.
Multiple contributors to top-line growth, more mixed on income
All of 3M's divisions delivered organic revenue growth this quarter. Healthcare led the way with 6% growth, while industrial and safety/graphics followed close behind with 5% growth each. Consumer was the laggard at 3% as poor winter weather hurt retail traffic.
Like Illinois Tool Works, 3M saw very good double-digit revenue growth in its automotive business (adhesives) which was well ahead of the mid-single digit growth in auto units (build rate).
Buy, build, or both?
3M has long tried to foster a culture of innovation, but management believes that they can do even more in terms of portfolio management and R&D reinvestment. The company generates about one-third of its revenue from new products (introduced within the last five years), but management wants to boost that to 37% over the next three years. 3M being 3M, the company is unlikely to make bold moves into entirely new fields. Instead, it will likely use existing businesses and end market relationships to leverage new products into the market.
Internal development has long been 3M's preferred option, but it is not the only one that management seems willing to pursue. Management has talked of spending $5 billion to $10 billion on M&A over the next three years, which is frankly pretty modest relative to the company's $5 billion annual free cash flow generation potential and its relatively underleveraged balance sheet. It may take some time for a major deal to materialize, though, as acquisitive deal multiples are generally not at attractive levels these days.
Slow and steady wins the race
3M seems positioned to generate long-term revenue growth in the neighborhood of 4% a year, with relatively less cyclicality than many in its peer group. Ongoing efficiency efforts should allow for some incremental FCF margin leverage, allowing the company to add two or three percentage points to its FCF growth rate.
Relative to the current valuation, those growth rates don't suggest that 3M is going to be a quick multi-bagger, but for investors looking for a high-quality name that can be held for years, 3M still looks like a good name to research further.
