Bridgeport began accumulating shares of 3M in the early days of the financial crisis (May 2008) and presently holds 3M shares in the Bridgeport US Equity Fund as well as select separate client accounts.
Our original thesis for investing in 3M was as follows:
Recession Proof Characteristics
3M is a 115 year-old company that has experienced more than a dozen recessions over its lifetime. After every recession, 3M has emerged in stronger financial shape than many of its competitors. Over the last couple of decades, the company’s financial strength can be attributed to several product segments with recession resistant characteristics as well as excellent product and geographic diversification.
Approximately 40% of 3M’s revenues are generated from the sale of products that have very low economic sensitivity including items such as medical tapes, surgical gowns, bandages, goggles, gloves, paint and various products that utilize the company’s proprietary reflective materials and its Thinsulate™ insulation lining.
Prior periods of economic turmoil have highlighted that revenues and profits generated from these business units are resilient which gave us comfort in 2008 that 3M could weather the storm through the recession. In addition, 3M has historically maintained a pristine balance sheet, and operated with net leverage under 1.5x net debt/EBITDA at the time of our initial investment.
Leading Market Positioning
3M is a global market leader within the industrial products sector and manufactures more than 55,000 products that are spread out amongst five core segments: Healthcare, Safety and Graphics, Industrial, Electronics and Consumer. The company’s products typically rank #1 or #2 in their respective categories, which is especially true in the tape (Scotch®), adhesive (Post-it®, glue sticks) and safety product verticals (Scotchlite™, Thinsulate™).
3M is also globally recognized for innovation and new product development capabilities. At the time of our initial investment, 23% of the company’s sales came from products that were introduced within the previous five years (3M calls this metric the New Product Vitality Index or “NVPI”). We believed that a strong product development infrastructure would result in a more durable and growing future earnings stream.
In addition to product diversification, 3M also benefits from strong geographic diversification. At the time of our initial investment, 65% of the company’s sales were generated outside of the US and were spread across over 65 countries. As a result, 3M was (and is) able to moderate the effects of regional economic volatility.
When Bridgeport first invested in May of 2008, 3M generated earnings before interest, taxes and depreciation (EBITDA) of approximately $6.6 billion on annual revenue of nearly $25 billion in its previous fiscal year. In addition, the business typically converted approximately 100% of its accounting profit (Net Income) into Free Cash Flow.
We purchased our initial share position in 3M at an attractive price which equated to 8.5x trailing EBITDA, which was about a 27% discount to the average valuation in the prior eight years.
In addition to the company’s compelling valuation, we were also attracted to 3M’s stable dividend yield of approximately 2.5% at the time of our investment. The company has a stellar record of paying uninterrupted dividends for over 100 years and has raised its dividend for 60 consecutive years in a row, which was a time-tested indicator of financial strength.