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Strong 3M Growth is Tempered by Weakening Margins
Posted by: Muhammad Bazil (IP Logged)
Date: August 3, 2013 02:43PM

3M (MMM) recently released its second-quarter results. A quick glimpse into the quarterly report reveals this:

  • Revenue increased marginally compared to the comparable quarter in 2012.GAAP EPS also recorded growth. Overall margins fell across the board.
  • Revenue Details

    3M recorded revenues of $7.75 billion. This was lower than the $7.77 billion that was forecast by 11 analysts earlier polled by the S&P Capital IQ. GAAP sales equaled those of Q2 2012.

  • EPS details

  • The EPS for the quarter was $1.71. This was equal to the earnings estimates provided by 16 analysts earlier polled by the S&P Capital IQ. The EPS was 3.0% higher than last year’s comparable quarter’s.

    Margin details

    Gross margin stood at 48.2%, 40 basis points lower than 2012Q2. The operating margin came in at 22%, 90 basis points lower than Q2 2012.Net margin stood at 15.4%,10 basis points lower than Q2 2012.

    3M’s stock is considered a defensive stock that mainly trades on a strong-margins basis. 3M’s repeated margin weakness in the 2nd quarter has begun to become a source of worry for many investors. This does not mean that the stock is an outright loser; quite on the contrary, 3M’s growth measures up quite well when you compare it to its major peers.3M’s stock is not rated as a growth stock capable of huge growth spurts. Nevertheless, 3M shares still look overpriced right now.

    Second quarter not that impressive

    3M deserves top-rate credit for strong margins, the stock’s defensive characteristics and the company’s respectable global footprint. On the balance, all these seem fine, but you can hardly fail to notice that that its performance is eroding.

    Revenue for 3M grew by 3% to $7.8 billion during the second-quarter, just above 2% calculated on an organic basis. About three-quarters of the growth was largely driven by substantial volume gains. Three-out-of-five of the firm’s business units recorded organic growth (the Health Care division registered 6% growth while the Industrial and Consumer unit grew by 3%). Business divisions such as Graphics/Safety as well as Electronics/Energy both declined by 2%.

    3M’s margins missed analysts’ expectations- again. Gross margin was down by 40 basis points, while segment profits declined by 3%, missing expectations by about 2%.The company’s consolidated operating income was down 2% while the operating margin declined by almost one point. Some of the 3M’s under-performance is attributable to acquisition-related costs; nevertheless, this was the 2nd straight quarter in which 3M operating line fell by four cents. If this trend continues in the coming quarters, it will eventually begin impugning on 3M’s solid reputation as a reliable all-weather margin play.

    Can 3M Maintain the Growth?

    3M’s performance comes off as okay when viewed against other industrial conglomerates that have already posted their 2nd quarter results; at least as far as growth is concerned. The company’s 2.3% organic growth in the second quarter compares well to conglomerates such as United Technologies (UTX), General Electric (GE), Danaher (DHR) and Honeywell (HON).

    3M’s share price continues to rise as you can see from this graph. There is a growing sentiment that the stock could at this point be overpriced when you consider the company’s fundamentals.

    Close Competitors

    For comparison purposes, look at this chart that compares 3M with its close competitors United Technologies and General Electric.
    P/E ttmForward P/E5-Year PEGPrice to salesReturn on EquityProfit Margin
    General Electric18.4013.661.361.7411.86%9.74%
    United Technologies15.2914.711.231.5820.49%10.16%
    3M Corporation18.3415.861.832.6725.70%14.80

    United Technologies seems to offers better value when you consider P/E and growth. 3M tops in margins. GE holds the tail-end for the coming year’s estimates of price to earnings ratios. The company, however, has the biggest financial division.

    All the 3 companies namely 3M, General Electric and United Technologies are heavily reliant on the US economy and their growth seems to mirror the recovery of the US economy.3M has a dividend yield of 2% and UTX has a similar dividend yield. GE has the highest dividend yield of the three conglomerates-3.10%.

    Although 3M’s relative performance in with relation to its peers is okay at the moment, this could potentially worsen in the coming quarters when you consider that the company’s sales did not decline like its peers’ did. 3M is likely to benefit from improving industrial demand in the global market and the recovery of its electronics unit which performed dismally during the quarter.

    3M is famed for its serial innovation and high efficiency. The company does not seem to favor buying growth companies to complement its businesses but instead prefers acquiring companies that build synergy with its innovation culture. In fact, 3M’s deals are mostly built around synergy with complementary business lines and not merely for growth. We are therefore not likely to see any huge growth spurts in the company anytime soon.

    Looking Ahead

    The revenue estimates for the coming quarter are $7.90 billion with a bottom-line EPS of $1.78.Revenue estimates for 2014 are $31.06 billion with a $6.70 EPS.

    Most S&P Capital IQ-tracked Wall Street recommendations rate 3M stock as a HOLD. The average price target is $110.19.Some analysts and investors (including myself), however, feel that 3M’s stock is overpriced and its fair value estimate is $105.00.

  • Stocks Discussed: GE, MMM, DHR, UTX, HON,
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