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MMM AT A GLANCE

P/E ► 18.7 AVG EV/EBITDA ► 11.3 AVG ROA ► 11% AVG ROE ► 22.8% AVG Debt to Equity ► 1.24 AVG Current Ratio ► 1.94 AVG Interest Coverage Ratio ► 19.3 AVG

 

 

 

 

 

 

3M is a diversified manufacturer with one of the highest international presences of any multi-industry company. With products such as Post-It Notes and Scotch Tape as well as high-tech LCD films, 3M develops innovative new products while turning a profit off of old favorites. 3M operates in six business segments: Healthcare, Industrial & Transportation, Consumer & Office, Display & Graphics (D&G), Electro & Communications, and Safety, Security & Protection. 2008 sales totaled $25.3 billion, an all-time high, and an increase of 3.3% from the year before. The company generated $6.2 billion in the third fiscal quarter of 2009 down 5.6% from Q3 2008. ^[1] Earnings were $1.35 per share in the third quarter of 2009, down 4.3% year-over-year. ^[1] Despite declines in both sales and earnings year-over-year, sequentially they were up 8.3% and 20.5%.^[1] Coupled with increases in operating margins and free cash flow, these figures proved very attractive to investors.^[2] Following the better-than-expected earnings release, however, 3M CEO George Buckley warned the company's sales growth recovery could flatten out as restocking of the company's products is completed. ^[3]

Most of the recent buzz surrounding 3M has focused on their LCD film production, part of Display & Graphics. Although not the largest segment of their business, the virtually uncontested market share 3M controlled in 2003 and 2004 led to impressive growth rates and profits. But increasing competition both from other film producers and from growing numbers of LCD monitor manufactures is putting a damper on 3M's operating margins in that sector.

3M is becoming increasingly global: in 2008, more than 64% of 3M's total revenue came from outside the United States.^[4] Its international penetration makes 3M well-positioned to take advantage of growing economies such as those of India and China, China, and Brazil.

3M has stepped up acquisitions of smaller international companies to spur overseas and portfolio expansion. In April 2008, 3M acquired Aearo Holding Corp, a company that manufactures and sells personal protection and energy absorbing products. This added hearing, eye, and fall protection to 3M's offerings. ^[5] In September 2009, 3M CEO George Buckley said it will acquire "different businesses" over the next year to continue to augment its product offering, ^[6] and will spend $1 billion from Oct 2009 to Oct 2010 on acquisitions. ^[7] The company is looking to buy products and brands that are well-known in their domestic markets in order to accelerate penetration of foreign markets. ^[7]

Company Overview

Business and Financial Metrics

3M's 2008 revenue totaled $25.3 billion, an increase of 3.3% from the year before and an all-time high. It's operating income and net income, however, experienced drops of 15.7% and 15.5%, respectively, from the year before. The drop offs in operating and net income can primarily be attributed to restructuring actions, exit activities and a loss on sale of businesses.^[9] A rapid decline in global business activity in Q4 2008 forced 3M to aggressively reduce its cost structure and rationalize several facilities.^[10] Furthermore, its sale of HighJump Software to private company Battery Ventures had a negative impact as well, further contributing to the decreases in the respective incomes.^[11]

Products

3M Company had a rocky start in 1902 as "Minnesota Mining and Manufacturing," an almost-failed mining company. In 2002 it changed its name to 3M; today the company is a diversified industrial and consumer products company operating six business segments. 3M sells the majority of its products to retailers or other large distributors; some large companies and hospitals have direct accounts with 3M for their more specialized technologies.

Best known for brands including Scotch tape, Post-It, and Nexcare, 3M makes over 55,000 products ranging from sandpaper and bandages to wide screen LCD TVs. The thread that unifies the majority of 3M’s products is that they are based on applying coatings to backings (e.g., sandpaper). Divisions with key product offerings are listed below:

• Healthcare (17% of 2008 Revenue): Medical Supplies; Skin Products; Pharmaceuticals (sold in 2007); Drug Delivery Systems; Dental / Orthodontic; Health Information Systems; Microbiology
• Industrial & Transportation (31% of 2008 Revenue): Abrasive Systems; Industrial Adhesives; Personal Care; 3M Dyneon; CUNO; Specialty Materials; HighJump Software; Aerospace; Packaging; Automotive
• Consumer & Office (14% of 2008 Revenue): Stationary; Office; Home Care; Protection; Construction; Home Improvement; Visual Systems
• Display & Graphics(11% of 2008 Revenue): Optics Systems; Commercial Graphics, Traffic Safety Systems; Touch Systems
• Electro & Communications (13% of 2008 Revenue): Electronics Solutions; Electric Markets; Communications Markets; Electronics Material Markets
• Safety, Security & Protection (14% of 2008 Revenue): Industrial Minerals; Commercial Care; Security Systems; Building Safety; Corrosion Protection; Occupational health; Environmental Safety

Business Drivers

International v. Domestic Economies

Strength in growing markets overseas

While the North American economy could continue to remain sluggish, it appears that overseas industrial markets continue to shine. This should bode well for 3M, considering that more than 60% of 3M’s revenues are derived from outside of the U.S. Furthermore, should the dollar remain weak, 3M could continue to benefit from it and other exchange rates. Considering that 3M’s products are largely positioned as consumables (e.g., filters, Post-it notes), growing international demand for 3M products should directly correlate with rising disposable income in developing economies over time. To this end, 3M expects annual revenue growth rates of between 15 and 30 percent for China, Russia, India, the Middle East, and Eastern Europe.

This will become increasingly important for 3M's largest international market: Asia. China, Japan and India are three particular markets where 3M has significant opportunity to claim market share due to growing economies and large populations. To target these opportunities, 3M has dedicated $500 million of incremental spending to expand capacity in the next two years in high-margin businesses like Safety, Security & Protection. The company estimates that it could be capacity constrained for up to 20% of its current volumes. In 2006, 3M announced new capacity expansion plants in Poland and Korea. In addition to these two initiatives, 3M has also announced plans to aggressively expand in Asia with 4 plants currently under construction in China.

Domestic slowdown

The American economy has recently felt the effects of a housing market bubble. Housing wealth is expected to decline in 2007, which could result in a decrease in U.S. consumer spending. An estimated 6% of 3M revenue is directly tied to North American consumer habits, especially for the Display & Graphics division, for which a third of sales are domestic and most LCD televisions are screens sold to end consumers. (See Home Entertainment Growth.)

Downsizing Pharmaceuticals area

3M completed the sale of its pharmaceutical division in January 2007 to multiple buyers for a combined $2.1 billion. This sale will allow 3M to focus on core product areas while still maintaining manufacturing rights for its former pharmaceutical products, a term negotiated in the divestiture.

Its European branded pharmaceuticals business has been sold to Meda AB, a Sweden-based drug-marketing company. Asian operations went to Ironbridge Capital and Archer Capital, two Australian private equity firms. U.S., Canadian, and Latin American operations went to Graceway Pharmaceuticals Inc.

LCD films

3M's proprietary products work to make flat panel display screens brighter by refracting usable light towards the viewer and recycling unusable light back through the display without absorbing light waves. This product is used mainly in notebook PCs and hand-held devices and to a lesser extent in TVs and monitors to make electronic displays more vibrant and thereby allowing a reduction in energy usage for these products by 50-70%.^[12]

Once the industry leader in this market, sales at 3M's Display and Graphics division dropped 6% during Q1 2008 and 16% during Q2 2008.^[13] This massive fall-off was caused when a low-cost producer entered the optical films market and began selling a lower quality film for a fraction of the cost of 3M's films. As a result, producers of electronic displays found it more profitable to buy cheaper/lower-quality films and simply engineer other aspects of their displays to achieve the brightness and definition traditionally achieved by optical films. This market development has resulted in a 2/3 drop in sales for the Display and Graphics division.^[14]

Growth through acquistions

Historically 3M has focused on organic growth, but recently it has become increasingly interested in acquisitions, especially internationally. In 2006, 3M purchased 18 companies for a combined revenue contribution of $450-$550 million for an investment of $750-$850 million.

One of the major expansion areas for 3M has been the market for LCD screens. The company dominates the global market for brightness enhancement films that are used by the flat panel display (FPD) industry for LCD applications in products such as LCD televisions, notebooks, desktop monitors, cell phones, and handhelds. The monitor market has historically been the largest piece of 3M’s LCD film sales. Its 2005 flat panel display film business breakdown was 60% monitors and TVs, 25% handhelds; and 15% notebooks.

Sensitivity to product cycles, seasonality

3M's fortunes in the flat panel display business are highly tied to the overall product lifecycle of these types of televisions and monitors. As the FPD business becomes more mature, prices decrease and margins are squeezed. 3M already saw decreases in its operating margins from 2005 to 2006, dropping from 33% to 28%.

On the upside, the 2006 holiday season created a major boost in LCD screen sales and consumers demanded larger TV and monitor screen sizes. 3M benefits from this trend because the company sells its films by surface area. Additionally, the 2008 Olympics in China could provide a significant boost for LCD television sales in China and elsewhere.

Increasing raw materials prices

Given the specialty chemical content that characterizes many of 3M’s products (i.e., adhesion and abrasion properties), raw materials and their associated prices can significantly influence the company’s margins. In addition to components and compounds, 3M consumes various energy products including natural gas. Over the past few months, the prices of key raw materials –-copper, natural gas, toluene, ethylene, ethane, benzene and polyethylene--have been on the rise trend, potentially hurting 3M's margins. Management expected the company's raw material costs to increase 3-4% for 2008.^[15] These price increases affect 3M through greater manufacturing, energy, and transportation costs. Furthermore, while the weaker dollar is good for 3M's sales, it has also effectively increased the cost of raw materials imported from outside the U.S. As of mid-2008, management has successfully mitigated these effects by increasing the price of 3M products more than the cost increases for raw materials.

Patents, Anti-trust risks

In the past, 3M has been known for its aggressive protection of its patents and has also faced anti-trust cases. Most recently, 3M is fighting a law suit against members of a Minnesota township who claim chemicals produced by 3M have made them ill.

Environmental Lawsuits

3M has been subject to lawsuits within the United States for the operation of its chemical plants. In 2008-2009 Minnesota lawsuit, three households allege that 3M scientists knew 3M was producing harmful chemicals but failed to report it, causing house values to decline in the area. Attorneys for 3M said the chemicals were introduced when there were few pollution laws. 3M also has said the trace levels of chemicals in water aren't a health threat. ^[16]

Competition & Operational Metrics

Since 3M operates in six different business sectors, it faces various smaller, more specialized companies in singular areas and a few larger companies cross sector, such as Tyco International (TYC). Industry & Transportation, Healthcare, and Display & Graphics, are the three greatest contributors to sales for 3M, so operational metrics for these three sectors should be examined separately.

Despite not being 3M's largest segment, much investor focus is on 3M's fast-growing Display & Graphics (D&G) segment, particularly because of its strength in the LCD film market, which represents most of the revenue for D&G. In 2003 and early 2004, 3M had a near monopoly selling to backlight manufacturers in the monitor, notebook, handheld, and LCD TV markets. The growth at the time was being driven by the monitors, a very high margin market for 3M.

Since 2004, as 3M experienced increased competition in its Brightness Enhancement Films area, organic growth and margins for the segment have come under more pressure. Its Dual Brightness Enhancement Films technology faces less pressure from competitors, but operating margins may decrease as a result of pressure on LCD screen manufactures to cut costs as the LCD industry becomes highly competitive.

The recent growth in large LCD screens (34 inches and larger) has been particularly beneficial to 3M because a cheaper alternative to DBEF for those sizes has not been made. If no replacement is found and the current trend in screen size continues, 3M's profits are likely to improve.

Division of BEF market: 3M (80%), Nitto-Denko (19%) , Mitsubishi Reyon(1%)

As the data below reveals, 3M is a larger company than its direct competitor Nitto-Denko and recently has had a better operating income. Also, 3M, as is consistent with their company mission, dedicates more of their revenue to research and development than either Tyco or Nitto-Denko, devoting 5.6-6.2% of its yearly revenue from 2006-2008 to research and development, compared to 0.59-0.69% of yearly revenue that Tyco spent on its research and development.^[17] This is valuable, particularly in sectors like Display and Graphics, because if 3M continues to invest the most in R&D, it will be hard for smaller competitors to generate cheaper products to claim some market share. High investment in R&D might also put 3M in a better position when it comes to expanding to international markets.

References

1. ↑ ^{1.0 1.1 1.2} AOL Money & Finance "3M Reports Strong Third-Quarter Results"
2. ↑ Steven Mallas Bloggingstocks "3M beats in Q3, delivers gain in free cash flow"
3. ↑ Dow Jones Newswires "3M CEO Says Sales Growth Could Stall in Q4"
4. ↑ MMM 2008 10-K, Item 1A "Risk Factors," page 15
5. ↑ MMM 2008 10-K, Item 1 "Business," page 4
6. ↑ Bloomberg "3M to Acquire ‘Different Businesses’ Over Next Year, CEO Says "
7. ↑ ^{7.0 7.1} Bloomberg "3M to Spend $1 Billion on Acquisitions Within a Year "
8. ↑ ^{8.0 8.1}
9. ↑ MMM 2008 10-K, Item 7: Management’s Discussion and Analysis of Financial Condition, page 18
10. ↑ MMM 2008 10-K, Note 4: Page 59
11. ↑ MMM 2008 10-K, Note 2: Page 53
12. ↑ 3M Q2 2008 Earnings Call.
13. ↑ 3M Q1 and Q2 2008 Earnings Calls
14. ↑ 3M Q2 2008 Earnings Call
15. ↑ 3M Q2 2008 Earnings Call
16. ↑ MSN Money, "3M contamination case heads to Washington Co. jury"
17. ↑ ^{17.0 17.1 17.2 17.3} TYC 2008 10-K, Item 1: Business, page 9
18. ↑ Google Finance: TYC
19. ↑ Hoovers: Nitto Denko