3M Posts Impressive 1Q as Profitability Rebounds

We plan to maintain our fair value estimate for  3M (MMM) after taking a look at the company's first-quarter results, filed Tuesday. The firm continues to churn out impressive sales growth and profitability, with volume climbing a robust 9% year over year during the period. Total revenue (including 3 percentage points of positive currency effects) jumped 15%. Operating margins slipped about 120 basis points to 21.6% from the same quarter a year ago, but negative effects stemming from the Japanese disaster constituted about 40 basis points of this decline. We suspect the company is still seeing continued raw-material cost challenges; however, we were encouraged to see profitability rebound sharply from 19.4% in the fourth quarter, driven largely by increased gross margins. We expect continued positive price action to further offset input cost pressure.

Not surprisingly, emerging markets such as India, China, and Brazil continued to drive sales growth for 3M during the quarter (up 24% from a year ago, to 34% of revenue), but the firm saw double-digit growth in the United States and Europe as well. On a segment level, the company enjoyed its strongest top-line gains in its industrial and electro businesses (similar to the past couple of quarters, outside the volatile optical films unit). Profitability also improved sequentially in every segment, with each business above 21% operating margins; we believe the weak margins seen in the fourth quarter of 2010 were probably an exception driven by poor pricing actions rather than a new run rate.

On the basis of this positive performance, management raised its full-year outlook slightly ahead of our current expectations. Excluding a $0.22 per share negative impact from increased pension expenses, the company now forecasts earnings per share in the $6.27-$6.47 range, up from $6.17-$6.42. That said, results could have been even better; management believes that lingering effects from Japan will reduce EPS by about $0.10-$0.13. As a result, we plan to adjust our near-term assumptions for the company, but we believe our long-term projections remain intact.

We're still encouraged by 3M's balance sheet. Although the cash and marketable securities balance slipped to about $4 billion from $4.5 billion at the end of 2010, mostly because of acquisition spending and renewed share repurchases, the firm's 8.6% net debt/net capital is still quite low, in our opinion. We believe this firm has ample liquidity for further merger and acquisition activity.

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