Sunday, July 09, 2006

3M Tumbles -- Now Attractively Valued

When Wall Street pukes out quality stuff, we're there waiting with a catcher's mitt.

Shares of diversified manufacturer 3M (MMM), which makes adhesive, coating, electronic, and health-care products, crashed 9% (on 8 x average daily volume) last Friday after the Minnesota-based conglomerate said that 2Q performance was impaired by lower-than-expected sales and start-up costs from its optical systems division. MMM's optical lens are currently used to augment the quality of LCDs for its flat panel TV customers, like Samsung. 3M CEO George Buckley says the news coincided with "an increase in inventory levels" in LCD televisions due to overestimated demand surrounding the FIFA World Cup.

Although we don't see any major catalysts down the road, we are believers in MMM's valuation, as well as the firm's importance as a proxy of the global economy (3M operates in more than 200 countries and makes more than 55,000 products.) For your own edification, just a couple of reasons why we're backin' up the truck and aggressively buying 3M:

1) 3M has historically plowed about 7% of its revenues back into R&D and subsequently been able to attract creme de la creme engineers to run labs.

2) 3M has a mean penchant for finding new uses for basic technologies, and then leveraging them across myriad platforms. Did you know that the optical lens 3M sells to enhance LCD screens evolved from technology originally manufactured to make road signs clearer?

3) 3M protects its patents the way pit bulls protect their owners. As a result, this wide moat company has coughed 18% operating margins over the last 5 years. It's no miracle that competitors looking to undermine 3M's brand empire (can you imagine modern life without Post-Its or Scotch tape?) are frequently rebuffed and sent home crying.

4) 3M has a free cash flow yield (FCF/12 month sales) of more than 15% and covers its debt obligations without breaking a sweat. The debt/equity ratio for last 12 month's is .24 and the company's ROE remains in the 30% range. A quick look at industry comparables will tell you that 3M's numbers are attractive.

5) We believe MMM's crash was a result of bad timing (summer doldrums and 4 year bull market temporarily handicapped by inflation-phobic Fed) and investor panic over a one time event. At 17 x 06 EPS and 14.3 x 2007 projected results, MMM looks like a bargain. A quality name like 3M can't be this cheap -- that's like Derek Jeter playing ball for $30,000 a year. We estimate MMM will earn $5.12 in 2007. Applying a reasonable 18 x P/E multiple ("reasonable" because the industry trades at 19 x and 3M has traded as high as 35 x over the last 5 years, but never lower than 17 x), we arrive at our $92 twelve month price target on shares of 3M, a 24% premium from Friday's closing price.

Disclosure: The author is long shares of MMM. Don't forget that you can also catch our recognized work at, a must read according to the New York Times, Reuters, Forbes, CNET, Wall Street Journal, and Barron's.

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