3M (MMM) reported strong Q3 2017 results with EPS of $2.33 (versus expectations of $2.21), an increase over last year of 8.4%. Organic sales growth was an impressive 6.6% as 3M had growth in all business groups across all geographies. Stock rallied 7% on the news.
Current Price: $237 Price Target: $188
Position Size: 2.3% TTM Performance: +46.7%
Thesis Intact. Key takeaways from the quarter:
1. MMM continues to execute well
• Organic growth of 6.6% was driven by strong growth in China +23% and Canada +14%
• US growth was up 3.6%
• Adjusted operating margins expanded 30bps y/y, reaching 25%.
• Updated 2017 guidance: bottom of prior organic sales growth range raised from 3-5% to 4-6%. EPS raised to $9.00-9.10 from $8.70-9.05. Guidance reflects belief that the strong operating environment will continue through the 4th quarter.
2. Segments trends:
• Electronics & Energy organic sales growth was +13.2%: electronics +18%, energy 2%. Continue to drive penetration in OEM electronics platforms
• Industrials growth +6.1%: good growth in building & construction markets
• Safety & Graphics organic sales was +6.0%: divested non-strategic business and acquired Scott Safety
• Consumer organic sales were +1.9%: good growth in home improvement
• Healthcare organic growth was +6.9%: strong growth in developing markets (China/HK and Latam)
3. Concerns exists despite strong results
• Valuation is high relative to history P/E of 28 is 1.4x S&P 500 average. The stock is supported by a 1.9% dividend yield, a 2-3% buyback program and a 4.5% FCF yield
• On the call numerous analyst asked questions regarding the quality of earnings
o Appears 3M underspent $.06 versus guidance of $.20-.25. Company said a previously unknown debt tender accounted for $.11 of this underspend
o 3M has been matching recurring costs with one-time sales gains, potentially overstating run-rate profits.
o Inventory to sales ratio has tracked higher – question of a change in rebating or discounting policy.
Thesis on MMM:
• Strong brand name, history of successful innovation, scale and low cost advantage help to drive above average returns.
• International expansion and pipeline investment should drive mid-single digit top line and high single digit bottom line growth. Emerging markets represent 47% of sales today and should reach 50% by 2020.
• The company is in good financial position and has a strong history of share buybacks, dividends and acting in the best interest of the shareholder.
• Quality management team with a decent incentive structure.