3M is one of the highest-quality industrial firms we cover, but slowing industrial production seems likely to limit the company's near-term prospects (as evidenced in recent quarters). That said, we still forecast mid- to high-single-digit, long-run organic growth and margin expansion stemming from further new-product innovation for this wide-moat firm, as we don't foresee market share losses or permanent margin degradation resulting from a slow-growth environment.
The firm's percentage of sales from products introduced within the past five years now stands above 30%, versus 21% in 2005, and should increase. Research and development spending has remained mostly constant since 2009, and 3M has also substantially increased its acquisition focus in areas such as biometrics and health care. Although we don't foresee much margin improvement from today's strong levels, we still project outsize long-run profitability.
|Economic Moat||Fair value||Stewardship Rating|
KEY INVESTMENT CONSIDERATIONS
- 3M generates wide profitability with only modest capital intensity. The firm has enjoyed ROICs north of our estimated cost of capital over the past decade, even during the recent recession.
- CEO Inge Thulin now believes that the long-run 7% to 8% organic revenue growth target installed by the firm's former CEO is a "stretch goal" rather than a base-case objective, in line with our roughly 6% organic growth forecast.
- 3M enjoyed strong U.S. growth in its most recent quarter, along with continued solid Latin American and Canadian gains. We expect low- to mid-single-digit organic growth to continue in 2013.
- Although 3M's recent success has stemmed from manufacturing initiatives, it is a technological innovator at its core, and it should continue inventing and marketing new products.
- 3M's balance sheet is very healthy, which gives the company the opportunity to finance future acquisitions with debt. The company has capitalized on attractive financing rates, issuing $1 billion in five-year debt at just a 1.375% coupon in late 2011 and another $1.2 billion at equally low rates in mid-2012.
- 3M aims to expand its already robust international focus. These overseas opportunities typically offer higher long-term revenue-growth and operating-margin opportunities for the company, as well as lower its effective tax rate.
- Through its wide diversification, 3M's portfolio is generally insulated from geography-specific economic issues.
- 3M is leveraged to both worldwide and U.S. economic production, and typically expands its top line at about 1.5 times the global Industrial Production Index. As such, the recent overseas slowdown has led to flattening organic volume growth.
- In order to continue its top-line growth, 3M must successfully integrate many acquisitions and continue innovating marketable products. Neither of these prospects is guaranteed.
- 3M has seen recent weakness in its consumer electronic-driven businesses, which could hamper near-term growth and dilute the company's profitability.
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