Founded in 1902 and originally known as the Minnesota Mining and Manufacturing Company, 3M Company (3M) is today among the world’s largest industrial conglomerates. Based in St. Paul, Minnesota, the company employs over 88,000 individuals worldwide and produces more than 55,000 products including adhesives, abrasives, laminates, passive fire protection, dental and orthodontic products, electronic materials, medical products, car-care products, electronic circuits and optical films, among others.
3M’s operations are comprised of hundreds of manufacturing facilities, distribution centres and research laboratories in more than 65 countries. The company’s products are available for purchase through distributors and retailers in more than 200 countries, and online directly from the company.
With a current market capitalization of approximately US$144 billion, 3M is classified as a US large cap stock. The company generates US$31.6 billion in annual revenue and $8.5 billion in operating earnings and is one of the oldest components in the Dow Jones Industrial Average.
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.
Since Bridgeport made its initial investment, 3M has increased its revenue by 24% from $25 billion to $31 billion and EBITDA by 31% from $6.6 billion to $8.7 billion.
As we expected, 3M’s product and market diversification led to relatively strong operating results during the recession. Organic revenue fell by 2% and 8% respectively in 2008 and 2009 (compared to a cumulative 46% stock price drop during the market crash) only to recover swiftly by 14% and 5% in the following years (2010 and 2011). Similar to prior recessions, we believe that 3M emerged a stronger company, as 3M continually invested in development of new products while competitors rationalized many of their cost centers in order to mitigate the ill-effects of the recession. From 2007 to 2011, the New Product Vitality Index increased from 25% to 33% and currently sits at over 40%, reflecting 3M’s diversified and sustainable sales mix. In addition, throughout the crisis 3M continued to increase its dividend payments as a signal of operating strength and future optimism. Because 3M’s recovery was so robust, many investors flocked to 3M’s bond-like characteristics, which resulted in a material expansion of 3M’s valuation multiple. This drove significant gains for shareholders.
Since Bridgeport’s investment in the company, 3M’s shares have increased in value by 246% (including dividends) as compared to a 133% increase in the S&P 500 Total Return Index during the same period.