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3M Company (MMM)

Minnesota Mining and Manufacturing, or 3M, was founded in 1902 in St. Paul, Minnesota. The global industrial conglomerate markets over 60,000 products used in homes, businesses, schools, and hospitals in more than 200 countries around the world. 

3M is a highly diversified company with five main business segments that cover over 45 technology platforms, ranging from adhesives and abrasives to ceramics and nanotechnology.

Industrial (35% of sales, 29% of income):
tape, sealants, abrasives, ceramics, and adhesives for automotive, electronic, energy, food, and construction companies.

Healthcare (19% of sales, 28% of income):
infection preventions supplies, drug delivery systems, food safety products, healthcare data systems, dental and orthotic products.

Safety & Graphics (18% of sales, 22% of income):
Personal protection and fall protection equipment, traffic safety products, commercial graphics equipment, commercial cleaning and safety products.

Electronics & Energy (16% of sales, 15% of income):
insulation, splicing and interconnection devices, touch screens, renewable energy components, infrastructure protection equipment.

Consumer Products (14% of sales, 12% of income):
post-it notes, tape, sponges, construction & home improvement products, indexing systems, and adhesives. 

3M is also diversified geographically with a large amount of international sales:

  • U.S.: 62% of sales
  • Asia & Pacific: 18%
  • Europe, Middle East, Africa: 11%
  • Latin America & Canada: 9%

Over time, 3M’s international exposure will only grow given that its foreign sales are growing much faster than its U.S. revenue.

Business Analysis

3M has paid uninterrupted dividends for more than a century and increased its dividend for 60 consecutive years. When combined with its consistently high operating margins in excess of 20% and excellent long-term track record of creating meaningful value for shareholders, it's no surprise that this industrial conglomerate has a number of competitive advantages.

First, many of 3M’s products are economically very attractive because they represent a small cost of the total product or project the customer is working on but are often mission-critical to the outcome.

For example, 3M supplies structural adhesives to automotive manufacturers. 3M’s adhesives bond plastics and metals together and must maintain their strength throughout the entire car’s life. The company’s brand, technology innovation, industry-leading reliability, and favorable product dynamics (low portion of the car’s total cost) provide nice pricing power, and it’s simply not worth risking the reliability of a vehicle for the original equipment manufacturer to switch suppliers.

Another benefit 3M enjoys is that about 50% of its products are consumables, meaning that customers need to continually repurchase them. The result is a far more stable cash flow stream for the company. Simply put, 3M has a very sticky product line that allows it to steadily increase its prices each year while retaining strong customer loyalty and a rising market share. This is why its industrial segment has historically grown at 1.5x the rate of the global manufacturing components industry.

The company's moat goes beyond product dynamics, however. 3M’s management team, led by CEO Inge Thulin, who has been with the company for nearly 40 years, has implemented a culture that embraces Lean Six Sigma and actively manages the company’s numerous operating divisions based on their profitability and growth characteristics. If a division is underperforming, 3M will take action to bring its returns up to an appropriate level and is not afraid to shed weak assets.

3M's management also understands the importance of maintaining a continuous dedication to strong R&D and new product development. Over the past 115 years, 3M has obtained over 100,000 patents thanks to one of the industry’s highest R&D budgets (as a percentage of revenue). 
Source: 3M Investor Presentation
3M also has a unique ability to leverage its R&D investments since many of the company's technologies are relevant across various end markets with only slight tweaking. As a result, 3M is able to more efficiently improve and expand its product range to take market share and remain relevant. In fact, about 33% of 3M’s sales are from products launched in just the past five years.

Finally, 3M has been among the most adaptable industrial companies in the world, with a great track record of investing in a disciplined manner into the industries and markets that offer the best long-term potential for profitable growth.

For example, 3M is investing heavily into products that serve the needs of the rapidly-evolving automotive industry. That means a focus on adhesives, connectors, and cooling systems for driverless and electric cars. In addition, 3M is rapidly gaining market share in data center cooling systems, which is an industry that is expected to grow strongly for decades.

Here's a look at the company's market priorities:
Source: 3M Investor Presentation
3M has also proven its ability to successfully enter and win market share in emerging economies, which are growing twice as fast as mature, developed markets. This includes entering China in 1984, where 3M now has nine factories and six R&D centers (it has 60 R&D centers global R&D facilities in total).
Source: 3M Investor Presentation
3M’s China business is its fastest-growing unit, consistently putting up double-digit sales growth. Management has also turned to acquisitions to boost the company's prospects, but in a conservative fashion. Specifically, 3M targets small, bolt-on deals, as opposed to large and often overpriced mergers that many of its rivals pursue.
Source: 3M Investor Presentation
In fact, over the past five years, 3M has only purchased six small firms and divested $1.4 billion in underperforming non-core assets, making for net acquisitions of about $4.2 billion. This shows that 3M is dedicated to growing organically, rather than risking overpaying for big deals to increase the top line at the risk of lowering overall profitability.

3M’s impressive organic growth is courtesy of two things - lavish R&D spending, and highly disciplined capital investment. Not only does 3M’s high R&D spending help the company maintain an edge in product quality and premium pricing power (as we previously discussed), but the firm’s surprisingly low capital spending (4.5% to 5% of revenue historically) is put to work with laser-like focus.

Specifically, 3M has been investing heavily in efficiency improvement, including more advanced quality control testing procedures based on automation, wireless internet sensing, and data analytics.
Source: 3M Investor Presentation
The result has been a tripling of quality control testing speed, while achieving an 80% decrease in product defects. This is just one example of 3M’s rigorous data and statistics-driven culture. In fact, the company has retrained more than 75,000 employees and completed over 110,000 efficiency improvement programs since 2001, resulting in approximately $17 billion in cost savings.

3M is currently in the late stages of a corporate restructuring initiative it undertook in 2015 during the last industry recession. The goal was to streamline the company’s businesses and organization to maximize efficiency and cut costs wherever possible.
Source: 3M Investor Presentation
Management also set a goal to improve the company’s economies of scale, via its global supply chain, to minimize its costs of raw materials. This has led to a steady decline in costs of goods sold and more than a 240 basis point improvement in gross margins since 2012. 

The company's margins should further benefit from ongoing cost savings plans, including a $500 million to $700 million reduction in annual expenses between 2016 and 2020.

Going forward, 3M believes that its fast-growing industries, presence in emerging markets, and higher margins should allow it to grow its EPS and free cash flow per share at 8% to 11% annually, an impressive pace.
Source: 3M Investor Presentation
Importantly, 3M has a good track record of meeting or even exceeding its long-term growth goals, which bodes well for the future of its dividend growth. All in all, 3M’s management team has proven it has the ability to constantly adapt to a rapidly changing world - but doing so in a highly disciplined, increasingly profitable, and very shareholder-friendly way that leverages its global strengths in technology, manufacturing, and brand building.

Key Risks

While 3M is among the highest-quality industrial companies in the world, there are still several risks current and potential investors need to consider.

First, virtually all industrial stocks will experience cyclical growth or declines over time. However, 3M’s efficient operations, high mix of consumables, and broad portfolio diversification mean that its overall earnings and cash flow are far more stable than the typical industrial firm. If anything, a temporary pullback driven by short-term growth concerns is probably a buying opportunity. 

The other major risk is that 3M’s success overseas, especially in fast-growing emerging markets, means that currency risk will increase. For example, analysts expect that fully 50% of 3M's sales will come from emerging markets by 2020. 

The currencies of such countries can be volatile relative to the U.S. dollar. If the U.S. dollar appreciates in value, local sales and profits will translate into fewer dollars for accounting purposes. Fortunately, currency headwinds and any other turbulence in international markets are unlikely to impair 3M's long-term earnings power. 

Closing Thoughts on 3M

When it comes to industrial businesses with long track records of dividend growth, 3M is one of the most impressive companies in the market. From its disciplined management team and diversified product portfolio to the company's strong balance sheet, substantial scale, and protected technologies, 3M seems like a great choice for many dividend growth portfolios at the right price. 

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