Several Reasons Why 3M Co. Can Outperform

It's no secret that 3M Co. (NYSE: MMM ) is one of the best run companies in North America, and it's also no secret that the company's stock valuation of 20 times current earnings is hardly cheap. The company is best understood as a play on global industrial growth, and in this sense it's useful to compare it to other industrial stalwarts, such as Illinois Tool Works (NYSE: ITW  ) and Emerson Electric (NYSE: EMR ) . With this in mind, investors need to ask themselves what 3M needs to do to make it a good value.

3M's relative value

The graph below offers a look at its valuation compared to Emerson Electric and Illinois Tool Works using enterprise value (market cap plus debt), or EV, over free cash flow:

First, its strongest profit centers (industrial, safety and graphics, and health care) continue to outperform its other segments.  The industrial division saw "strong double-digit organic growth" in 3M Purification (liquid and air filtration), according to management on the conference call. In addition, according to statistics, personal safety is its largest business and generated double-digit organic growth in the first quarter and health care segment is seeing strong growth in developing markets and saw sales up 10% in the quarter.

Second, 3M demonstrated some impressive pricing power in the first quarter, giving the company leeway to invest for future growth. Overall constant currency sales growth was 4.6% in the first quarter, with volume growth contributing 3.4% and pricing 1.2%. The global economic recovery has been slow for some time, and pricing power has been hard to come by for many companies. It seems that it's coming back for 3M, however. Moreover, gross margins improved by 0.5% to 48.5% in the first quarter. Management was clear that they intend to invest $0.10-$0.20 of earnings into new product innovation.

Third,i current trends are favorable, and 3M can expect somewhat of a bounce back in the U.S. due to the severe weather conditions hampering growth in the first quarter. According to CEO Inge Thulin, the company " delivered positive organic growth in all business groups and geographic areas, we posted strong margins across the portfolio and we returned a record amount of cash to shareholders." 

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