Tuesday, March 17, 2020

MMM Analysis - Part 2

This is a continuation of 3M's analysis.

In the last post, we gave the background on 3M and why it's a good stock. Today, we shall formally write down its investment thesis, analyze the other positive factors, look at its risks and finally determine whether valuations are reasonable. I find that documentation is really a good practice for all investors. It makes the whole process transparent and we can look at to learn what worked and what did not. So, do write down our thoughts before buying or selling, even if it's just one line.

Okay, here's 3M's investment thesis:

3M is an innovative industrial conglomerate that has built its brand in safety, healthcare and other niche segments in infrastructure and consumer businesses. It benefits from growth in Asia and US healthcare on the back of strong pricing power. The management understands capital and resource allocation well and has delivered a stellar track record of shareholder return. It is also one of S&P Dividend Aristocrat.

The Dividend Aristocrat is a list of stocks in the S&P500 index that has increased its dividend payout for at least 25 freaking years. As of 2020, there are 64 stocks according to the wikipedia page. The table below shows an old list with the annual returns and absolute price change. It seemed that one can get a high single digit return by any dividend aristocrat stock.  

Dividend Aristocrat - Old List

Let's return to 3M, so we have got the investment thesis. We would want to support it with a few strong points. In investment lingo, we usually call these positives. As alluded above, 3M has a few positives going for it. Its growth sectors are Asia, which makes up c.30% of sales and healthcare, which makes up c.25%. There could be some overlaps so growth in total might be 35-40% of sales. As these portions grow, earnings improvement could accelerate from the current low single digit levels to something closer to its historical performance (13% according to the table above).

How did we get these numbers? Can we be sure Asia and Healthcare makes up 35-40%? Well, we can never be 100% sure. It is just a ballpark. In the past, Warren Buffett spent all his time scouring through annual reports/10K year after year to figure all these out. We can still do that today, but analysts, Bloomberg and reports usually do a good job putting all these together. The following are the segment and regional splits we can get from its 10K. The parts in red are of our interest.

3M EBIT split, margins and short descriptions:

Healthcare 24%, OPM 25%, skin and wound care, infection prevention, patient warming and oral care, food safety indicators, coding and reimbursement software etc.

Transportation and Electronics 28%, OPM 23%, display materials and systems, automotive and aerospace, advanced materials and transportation safety etc

Safety and Industrial 34%, OPM 23%, personal safety, adhesive and tapes, abrasives, automotive aftermarket, roofing granules, electrical markets etc.

Consumer 14%, OPM 22%, consumer tapes, Post-It notes, home air filtration, cleaning products, bandages, braces and supports, retail abrasives etc.

Geography split:
US 39%
APAC 31%
EMEA 21%
Latam/Canada 9%

As we can see, 3M enjoys good margins across its business segments. None of the its businesses are below 20% margins. Its geography split is also well-balanced with growth regions making up half or more of its overall revenue. Its ROE is even more spectacular at 40-50% annually over the last few years. Besides its high ROE, we also know from the slide below that 3M is laser focused on good capital allocation and shareholder return.

As such, 3M's exposure to growth sectors (healthcare and Asia), its stellar track record of capital management built on the back of its strong brand rounds up the investment thesis for 3M. Needless to say, it benefits from idiosyncratic events such as the coronavirus outbreak precisely because of its strong brand as a safety and healthcare pioneer.The stock is also a leading barometer for the industrial cycle. It is usually the first stock to recover at the bottom of the cycle. Hence by having the stock in the portfolio, we then tend to be able to monitor the cycle better which helps with our assessment on the other stocks in our portfolios.

In the next post, we shall look at 3M's risks and valuations.

Huat ah!

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