Our Take on 3M's Fourth Quarter

 3M (MMM) reported continued slowing internal sales growth and profitability erosion, as further struggles in the display and graphics segment, seasonal weakness in consumer and office, and increased pension costs offset strong growth in the industrial business.

For the quarter, consolidated revenue climbed 5.7% year over year, but the 1.3 percentage points of internal volume growth within this figure was the lowest since a decline in the third quarter of 2009. Still, we're encouraged that the company was able to once again garner substantial price improvements (up 2% in the quarter and 1% for the full year), while still seeing decent growth in the United States (volume up 3.7%) and Latin America (up 8.6%). Although 3M's operating margin slipped slightly from a year ago (to 19.2% from 19.4%), management reaffirmed its 2012 outlook, which is in line with our current projections. We plan to maintain our $100 fair value estimate.

The display and graphics business saw further difficulty in the quarter, with revenue falling 8.8% year over year. Once again, optical film led the march downward, dropping 17%, although operational improvements led to a 330-basis-point jump in operating profitability for display and graphics. Elsewhere, margins remained relatively flat with the fourth quarter of 2010, but the company saw a 100-basis-point headwind from higher pension costs. We expect quarterly profitability to improve, as the fourth quarter has proved to be seasonally weak, and we feel comfortable with our 2012 operating margin estimate of 21%-22%, slightly above 2011's levels.

We're encouraged that the company is seeing bright spots in key areas; in the fourth quarter, it enjoyed double-digit top-line increases in abrasives, aerospace, industrial adhesives, and personal safety. However, we caution that the quarterly declines seen in display and graphics and electronics (down high single digits) have tended to lead weakness in the other segments in the past. As such, we think management's full-year target of 2%-5% internal sales growth, with weak first-half results due to difficult year-over-year comparisons and continued European challenges, seems reasonable.

3M continues to enjoy a great deal of balance sheet flexibility and finished the year with nearly $3.7 billion in cash and marketable securities versus $5.2 billion in debt. The company has already announced the $550 million purchase of  Avery Dennison's (AVY) consumer and office segment, and we anticipate further bolt-on purchases as the year progresses.

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