The global economy is going through a tough period with continued weakness in western Europe and slower growth from China. For 3M (NYSE:MMM), which gets about 65% of its revenues from outside of the United States, this translates to a challenging situation.  Typically, in such an environment, when manufacturing companies face a decline in demand they respond with lower production rates which impact margins through increased inefficiency.
So, will 3M whose operating margins have stayed at impressive levels of over 20% face a significant decline in margins in the current low growth environment? We don’t think so.
We anticipate 3M’s margins to remain largely stable due to a strong product mix that consists of a large portion of new and innovative products that generate higher returns. In addition, the company’s emphasis on productivity through lean six sigma will also help it prevent a sharp decline in margins.
We currently have a stock price estimate of $110 for 3M, approximately in-line with its current market price.
High Share Of New And Innovative Products In 3M’s Product Mix
3M spends close to 5.5% of its sales on research and development.  As a result, it is able to introduce new products at a rate which is generally not seen at other manufacturing companies. In 2012, the company generated around 30% of its revenues from products that were launched in the past five years.  These newer products have higher margins compared to older products which face pricing pressures due to competition catching on. Thus, a high share of new products in 3M’s overall sales will help maintain margins in the near term. This was also evident from last quarter’s results where 3M posted operating margins of 21.6% despite being faced with a challenging macro environment in many markets.
Looking ahead, the company plans to increase the share of new products in its total sales by increasing spending on research and development (R&D). 3M currently targets to raise the proportion of its sales generated from new products to 40% by 2017. Over this time frame, it will increase spending on R&D to 6% of its total sales.  This high proportion of new products in 3M’s overall product mix will help it maintain margins in the long term.
High Productivity Through Six Sigma Implementation
3M’s margins also receive support from the rigorous implementation of lean six sigma, which involves inventory reduction, business process and organizational structure changes aimed at reducing costs and driving up employee productivity.
These strategies have helped the company consistently post operating margins in excess of 20% over the last several years – 21.7% in 2012, 20.9% in 2011, 22.2% in 2010, 20.8% in 2009 and 20.6% in 2008.  Notes: