3M India: Stock to Postit in a portfolio

dd1474 · January 23, 2019, 2:51pm

Background
3M India Limited is 75% owned subsidiary of 3M Company, USA. In 1988, 3M India began its journey as Birla 3M Ltd, a joint venture between 3M Company and the Birla Group. In 1991, Birla 3M India was listed on the Indian stock exchanges and only in 2002 did the company’s name change to 3M India Ltd. It’s the seond only listed 3M group beside 3M Inc in United States.

The Company manages its operations in five operating segments: Industrial, Health Care, Safety and Graphics, Consumer and Energy. In India, the Company has manufacturing facilities at Ahmedabad, Bangalore, Pune and has a R&D Center in Bangalore. 3M India’s five business segments bring together common or related 3M technologies that enhance the development of innovative products and services and provide efficient sharing of business resources. Most 3M products involve expertise in product development, manufacturing and marketing, and are subject to competition from products manufactured and sold by other technologically oriented companies.

For more details about parent company please visit following link
https://investors.3m.com/overview/default.aspx

3M India Limited is a technology company. The Company’s segments include Industrial segment, Health Care, Safety and Graphics, Consumer and Energy.

Source: FY18 Annual report

Research driven business:
During FY10 to FY18, 3M india has spent Rs 481.03 Cr on R&D with average of 3.23% of sales. Very few MNC have utilised Indian subsidiary for research. 3M India research initiative has resulted in major success with nearly 100 patents filed by 2016. The research unit focus also developing products specific to Indian market.

Globally 3M is among the most innovative company with nearly 113,000 patent filed over the period.

Critical subsidiary for parent:
In very few countries 3M has subsidiary with 75% equity holding. In 2017 form 10K filed by 3M with SEC, the minority interest item has explenation which give understanding that beside India, none of the other major country 3M has minority partner.

Further, during intial period, 3M has supported Indian subsidiary by waiving of royalty payments. Find extract of relevant portion from Annual report of FY18 of 3M India.

During FY10-18 period, total royalty payment by 3M India to Parent is Rs 156 Cr which is lower than Income earned from Parent for Contract Research of Rs 158 Cr.

Lastly, 3M US has a fully owned private limited company as subsidiary by name 3M ELECTRO AND COMMUNICATION INDIA PRIVATE LIMITED which was registed in 1989. The company is now in process to merged with 3M India. Details of financial and other terms of merger are in enclosed presentation.
https://multimedia.3m.com/mws/media/1585456O/agm-2018-presentation.pdf

The company would be making total cash payment of Rs 590 Cr. 3M electro reported net profit of Rs 22.8 Cr during FY18, which mean acquisition P/E of around 26 times. While amount paid is probably at higher end of unlisted private limited company, it ensure that 3M India would be the only entity for business in India for 3M USA.

Business Propsect:
3M India growth prospect are highlighed by management in presentation made to sharheolder in AGM of 2018. It is very difficult to project future sale and profit growth as there are more than 10,000 product of 70,000 product marketed by 3M US. What is interesting is despite industrial growth in India being lower during last 4-5 years, 3M Industrial segment has been showing very healthy profitable growth duing the same period.

Segmentwise Sales and PBIT

While Index of Industrial production (as published in Economy survery of Jan 2018), has growth at CAGR of 3.7% p.a. during FY12 to FY17 period, 3M India Industrial sales registered CAGR of 8.9% p.a. during same period. Even after adjusting for inflation of 3% p.a., as against nominal growth of 6.7%, Industrial segment sales has outpaced Indian Industrial growth. Industrial segment PBIT had registered growth of 21.5% p.a. CAGR during same period.

That give confirmation that 3M India can grow profitably even in difficult market conditions.

3M India in its presenation to Shareholder has shared interesting graph which indicates sales in USD/ mn USD nominal GDP. As expected, India GDP penetration is lower than most of the countries.

If we compare same with other industries, the gap appear to lower (with China being almost at same level to India). Having said that, mutiple product, superior quality and near mononpoly situation may assist 3M India to register higher growth.

It is pertinent to note that the gross margin on traded sales (traded sales- purchased finished goods) in 3M India has been in very high range of 44% (lowest during FY14) to 54% (highest during FY18) during FY11-FY18 period. Average Gross margin around 48% which indicate very high pricing flexiblity of the company.

The most critical aspect on 3M India business operations is to understand Indian market and “Indianise” product or service it offer to the customer. Find enclosed article which explain concept behind launch of Car Care units by 3M India. Nowhere in global market, 3M has such srevice being provided. However, looking at Indian market characterstic, it develop a structure which can address customer need at the same offer to leverage of mutilple product the company has to offer to customer.

The same article in 2013 provide aspiration goal of 3M management to reach USD 1 billion by 2017 which it defintely failed to meet on Topline for sure. In FY18 sales of Rs 2500 Cr is not even 50% of the stated sales goal. However, from 1 store in 2010, the company has successfully 100 stores in FY2018.

Risks
High Related party transaction
3M India has very high portion of purchase which is sourced from related party. While the shareholder approve the related party deals, still it may not rule out the risk of unfavourable treatment to the minority shareholders.
Having said that, the company management has shown high integrity in business conduct. Further, I have no knoweldge of unfair treatment being given the minority shareholder in past.

Exchange rate volatility
3M india is exposed to exchange risk volatility (USD INR) due to high level of import traded products and neglible exports. In past, adverse exchage rate movement has adversely affected the company quarterly financials.

However, most of the products marketed by the company are innovative and much superior quality and performance. As a result, it emjoy high pricing flexiblity (kind of monopoly in many of products) and pass on same within 3-6 months period after rupee depreciation.

Very high valuation
3M India would be among the most expensive company if one consider P/E multiple as valuation parameter. At market price of Rs 20,700 it is trading at Trailing 12 months PE of around 68 times which is super rich valuation.

It may be interesting to note that since March 1994, closing PE for 3M India has been average of 74 times, (Median 63.8 times, Max 638 times and Min, 15.4 times). So rarely company come in attractive value zone for investor, only 21 months of 299 months, closing PE was less than 20 times while on 172 months of 299 months, the company traded at PE higher than 50 times.
3M Past price data.xlsx (38.0 KB)

Incentive to Indian Top Management
3M india executuve compensation have stock option of 3M USA. This may be concern for minority shareholder as Top executive performance would be more align to parent then Indian business. However, 75% stake of parent in subsidiary and also no past incidence of wrong conduct on part of Global management specifically adversely afffecting minority shareholder rights address this concern to an extent.

Link to Business of 3M along with other details.

Disclosure: I had tracking position in the company more than 3 years and recently added as Core holding in my portfolio. My view may be biased due to my investment. Further, I am not a SEBI registered advisor. Investor shall do his/her own due diligence and consult investment advisor before making investment decision,

kanvgarg123 · January 23, 2019, 8:38pm

We studied the strategy of 3M in detail at my B school. The company has a strategy where they try to launch innovative products and milk them in first 4-5 years and then reduce the prices as and when the competition comes. Their R&D capabilities are in its own league altogether. The only reason I didn’t buy stock was valuations and I guess it will still remain the same. The question arises if we should pay 68 PE for a 20% growth stock at historically their peak gross margins.
Kudos for the great initiating coverage.

Regards
Kanv

rupaniamit · January 23, 2019, 10:33pm

Thank you @dd1474 for starting the thread on 3M India. I studied 3M India mid of last year and was blown away by the amount of FCF that it has generated without needing any capital to generate incremental FCF. It’s truly great business with great potential in a country like India! It has tremendous longevity something that is rare to find in today’s fast moving world.

A rational and conservative investor would not assume that the business will still be available at PE of 70, 10-15 years down the road. In fact, Prof Bakshi has written in one of his posts that the max exit PE multiple he gives to any great business is 15x, 10 years down. And he has shared that he thinks more in terms of expected return. Even if I assume that exit multiple will be 30x and PAT grow at 20% CAGR for next 15 years (Motilal’s 23rd Wealth Creation has shown that only 1 or 2 businesses have grown PAT consistently at CAGR of >25% for 15 years), expected return is less than 13%. This shows that 3M has to be unique which only 1-2 business have done so far, and there is no room for error, and everything has to hit perfectly every year for ~13% CAGR return.

3M India generates tremendous amount of FCF but doesn’t share it with investors. So far it has not distributed any dividends. I prefer my core holding to have some dividend yield.

If you prefer to share, I’d like to know your thought process behind expected return from this “core holding” of yours (and I guess many other forum members would also be interested).

Disc: Spent a lot of time understanding both 3M India and 3M USA. Ended up investing in 3M USA as core holding in my portfolio which I intend to hold forever .

solankidarsh · January 24, 2019, 3:18am

Hi when you say you invested in 3M USA do you stay in India or do you stay abroad. If you stay in India could you share the way you invested in 3M USA.

ranjan_r · January 24, 2019, 4:42am

hi @dd1474, quite agree with the valuation technique you used . Can you let us know how to value the intangibles which 3M india have ? . it can give a idea why it quote at such high valuation…

dd1474 · January 24, 2019, 5:14am

@kanvgarg123 @rupaniamit
Thanks for your feedback first.
In my limited understanding, if the company has long growth path and low pentration rate, then business would have higher valuation. Since I am looking at kind of 5 year plus holding in my core portfolio, I am not so much concern about entry multiple. The second point to consideration is my exit multiple.

I am enlcosing screenshot from Excel downloaded from Screener for P&L of 3M India.

Look at FY11 to FY14 period. While net profit for the company almost halved during the period from Rs 99 Cr in FY11 to Rs 43 Cr in FY14, still we find share prices remained stagnent at Rs 3700/- as on MArch 2011 to Rs 3711 on March 2014. So despite drop in profit by almost 50%, there was no correction in share price. One may assume that market was anticipating the growth in future which was discounted in price. However, if that was the case then price would not have rose with increase in profit. What we see is double in profit in FY15 to Rs 108 Cr, resulted in also almost similar increase in price. It is difficult phenomenon to express except that stock float being very limited and held by the investors who are willing to stay with company for long period. While there are no two opinion about value being streched, probably over period it would adjust as highlighted by Amit. However, I would tend to believe that exit mutiple realignment may not be happening in next 5 years. In case my assumption is wrong, I would get negative to marginal wealth creation by 3M in portfiolio. However, if my assumption is correct, I may get around 20-25% growth per annum (which is my expectation of profit and EPS growth in 3M).

I am not at all advocating that 3M is cheap and profit growth will simply translate in price growth.

On second issue about divided, which I missed during first message. Generally, I do not invest in the company which has no dividend payment. However, when company can deploy money in business which generate return on capital of more than 20% over decade (last being around 30%), and I trust the management, then I would rather like company employing free cashflow and compounding wealth for me then to get as dividend. In fact, while it is very tempting to invest in 3M US given 2% dividend yield, the growth in India would definitely double of Global business and hence personally would prefer to invest in Indian subsidiary.

Thanks for bringing out valid concerns once again.

rupaniamit · January 24, 2019, 12:11pm

@dd1474 - thank you for sharing your expected return thought process! I agree with you on India growing at much faster clip than 3M’s other global businesses. Since my investment horizon is “forever” - entry multiple becomes very important. Multiple compression + zero dividend in India would not help me much. 3M US would still benefit from India and China growth, directly and indirectly. Looking forward to learn market lessons through 3M India.

@solankidarsh - I’m a full-time investor and live in the US.

rupaniamit · January 24, 2019, 12:29pm

I agree with you 100% here. Even I would let management deploy FCF at higher ROCE. But in case of 3M India - based on what I have seen in financial statements - incremental FCF is not generated with incremental deployment of capital. Look at the meager amount of CAPEX that has gone-in in last 5 years and tremendous amount of FCF that has been generated. It’s sitting on close to Rs. 800cr cash today. It doesn’t buy-back shares (and I would not want them to buy back at current valuation). Management doesn’t conduct con-calls. I am very curious to understand their plans to utilize free cash and future FCF.

Investor_No_1 · January 24, 2019, 1:29pm

Interesting and this becomes even more interesting when you mention in your post above that incremental need of capital is negligible. So where is the money going? If its not distributed back as dividend or buyback and business doesn’t need much. Can you or anyone share thoughts?

I am a huge fan of 3M products and their innovation. Ideal company to invest in for decades even if I find valuations high. I would rather keep adding more everytime corrects in such kind of company. Only thing that has so far prevented me from buying it is the long term strategy of its parent in India and vision of 3M USA for 3M India that I do not know. One fine day, if they sell or wind up or do a buy back and exit, I do not know whether minority investors will be kept in mind. If they suddenly start introducing products directly via unlisted subsidiaries or 3M USA, jut like Abbott Healthcare, it will be of no use to me. This is a big uncertainty for me over long term. I can invest in Indian origin innovative companies with similar 20% CAGR (Godrej, Marico, Pidilite - Hugely innovative although not comparable directly). 3M is class apart and I admire it most, but sadly I am not able to overcome my uncertainty so far to buy a single share. Am I over thinking on these points and missing on this beautiful business, pls let me know. Thanks

rupaniamit · January 24, 2019, 2:17pm

Money is with the company, sitting on balance-sheet, parked in liquid instruments generating close to risk-free return. Looking at financials of last 4-5 years, it looks like business doesn’t need a lot of additional capital to grow. This might change in future. They might have 1-2 year of heavy CAPEX and then slow 4-6 years of maintenance CAPEX. They might tap into 800cr cash and use it for capex to launch new products. If I was an investor, I’d be very happy if company is allocating cash to some use knowing their execution capability and track record. But at the same time I would like to know their plans for utilizing 800cr and if they have no plans, then give it back to investors. I reached out to IR team to know their plans, but didn’t get any response which was disappointing. I wish I could go to AGM and ask questions directly.

I don’t think you are overthinking. Some of the concerns have very low probability (imho), but still can’t be ruled out. Funny things can and will happen in stock market. You are being skeptical and as an investor one should always be skeptical when hard earned money is being invested. These are valid concerns. I’d attend AGM and get clarity.

basumallick · January 24, 2019, 2:33pm

@dd1474 3M is a known great company. It has a truly great set of innovative products. My question to you is simple, What is new? What has or is changing? Or is it just that you are looking for a safe haven in a turbulent market?

dd1474 · January 24, 2019, 3:12pm

Well nothing has changed. While it was always expensive despite great business. However, what has changed (for me) when I looked at last 20 years valuation parameter. We feel company can grow at 20% for next decade or so. No issues on that part. The concern was decline in exit multiple may reduce my return. However, when I seen the company has been trading with median PE of 68 times over last 20 years and I assume that Indian economy would continue to grow at 7-8% for next 10-15 years, I do not see reason for PE to decline drastically in next 5-10 years. My understanding may be wrong.

So 20% net profit compounding company with ROCE of 20-25% and indefinte hunger to deploy capital at same rate. My sense is giving me view that despite 65 PE, the company is cheap but I do not have objective/mathematical/financial model to substantiate same.

@rupaniamit
During FY10 to FY15, total operting cashflow was Rs 541 Cr, of which Rs 440 Cr was spent on Capex. During FY16 to FY18, as against total operating cashflow of Rs 655 Cr, the company has spent only Rs 40 Cr, and accumulated Rs 610 Cr (partially would be utilised in working capital). The reason for saving cashflow may be proposed Acquisition of 3M electro which would require Rs 590-600 Cr capex. So, I see company has planed saving for future proposed acquisition. My understanding may be wrong.

KC1986 · January 25, 2019, 12:44pm

Can you please clarify this point with some quantification apart from the GDP growth which you have already mentioned. There is no doubt about the management capability and their strategy along with their execution in last decade. But question comes in the sustainability of this growth. If this growth [20%] will sustain then 60 PE is very reasonable one considering the quality of the business.

dd1474 · January 25, 2019, 2:12pm

It is very difficult for any one (including maangement) of 3M to substantiate growth. How would be project growth of Post-It, Autocare, Abrasive, Films and more than thousands of product with highest contributing less than 5% of sales? So the best way is look at segment, like Industrial (accounting for 40%, Healthcare, Safety Graphic, Energy and consumer. Since Industial, Energy and Safety graphic are linked to Industrial production/Infrastrucutre, I considerd that and tried to justify topline growth.

One more way to take at last decade topline growth in China. 3M China sales has increased at USD 1100 mn in 2007 to USD 3255 mn i…e. at CAGR of 11.5% p.a.

Find enclosed one picture on sales breakup of 3M in China for which I have enclsoed link of international business presenation of 3M

3M has constantly launched new product and put efforts to change sales from Trading to Manufacturing. They are repeating similar efforts in India as well.
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjE1MzcxfENoaWxkSUQ9LTF8VHlwZT0z&t=1 (Refer to slide 20 in presentation)

In India also, during last last 8 years, 3M India sales grew at 11%, with PBIT CAGR growth of 20%.

So very simlistically, if I assume past is indicator of future, then 20% growth in earning does not appear superlative as the company has achieved in last eight years same growth with 11% p.a. CAGR in topline. This is probably too simplistic, but frankly, I do not any other way to answer the profit growth of 3M.

ChaitanyaC · January 25, 2019, 2:23pm

What kind of downfall do you expect if your expectations are not met in the near-term, say 3-5 years (as it trades at a very high PE, hence the fall could be high too)? And how confident are you that in the long-term, say 10 years, that it will recoup the losses and will return this 20%?

I am not sure if I could put 3M along the lines of Page and Dmart, Page gives dividends, Dmart has still a long way to go and perhaps in the future it too distribute dividends. Do you feel these could be compared?

dd1474 · January 25, 2019, 2:46pm

3M USA has given dividend without break for last 100 years. Please look how 3M China has grown. They attempted to reduce imported products which they are also doing in India. So that along with operating leverage and productivity (which partially shared with lower price) results in higher demand and hence higher margin. If they can deploy capital at 20%+ in India, why shall they distribute dividend.

Finally, it is individual call and I anyway do not suggest whether 3M is good investment for everyone. I have put my rational and understanding. In first message itself I am saying that it is expensive stock. I have also given details of last 2 decade PE. Please refer to same. I do not have any further points about high valuation.

ChaitanyaC · January 25, 2019, 3:18pm

My question was more related to the fall and not about dividends. I would like to know what kind of fall should one anticipate considering the high price, provided one has the intention of buying it and holding for a long time. Did you think of any possible fall scenario and the time it will take to return to the price it fell from? In 2009 April it has fallen to 900 from 2300, and it took just 1 year to return to 2300 price. Did the management communicate then and give any assurance?

I know that this is not a good investment for everyone. But if one were to consider it as a prospect, one has to either have a heart to see it go down by 50% and still feel confident or one has to grow brains to predict such a fall and get out before it happens. I guess I have such a heart so would like to know your approach as this is your core holding and you must have looked at this from all possible angles.

P.S A novice and enthusiast, so these are all questions, doubts.

jamit05 · January 25, 2019, 3:56pm

From just looking at the chart.

3M is as good a company now, as it was ten years ago. Therefore, we can use the 2008 fall as a reference. In 2008-09 period, it fell from a high of 2300 to 850, that is a 60% fall.

Besides that, it has fallen around 20% to 30% on several occasions. But, yes, 60% is the most it has ever corrected from the top.

Can someone post a PE chart for 3M. It will be a great source of reference.

KC1986 · January 25, 2019, 6:13pm

Thanks for elaborating @dd1474. So the conclusion is [as far as I have understood ] we are looking for 11% topline and 20% bottom line growth and with Smart Cities lined up it is quite achievable. But can we compare the growth story of China & US directly with India? Since there are huge difference in consumer dynamics and political landscape of India. So I have very specific question …

Can we have the segment breakup for their revenue[as you have mentioned in the starting topic] and from which division they are expecting the maximum growth [at what %] in next 10 year? [as you already mentioned industrial form their 40% sales]
What is the moat / economic advantage they are having?[like distribution network, low cost producer via economy of scale etc. ]
As you have mentioned that they are changing from trading to manufacturing. How will it going to impact their margin ? How much improvement we can expect for this change of strategy?

dd1474 · January 26, 2019, 4:11am

@ChaitanyaC
First My apology in case my revert has given any harsh feeling. It was not my intention.

On point of decline in price in 2008, I believe 60% decline from top would be among lowest. I do not have any data to support but it is my belief. I was not holding shares then and hence do not know whether there was any communication by 3M management.

Thridly, in my view, equity valuation is more of art then science. Frankly, I do not believe I can project growth of 1 year, where is question of 10 years? Having said that, what I try to check is direction of growth. Based on my understanding, I believe next decade growth would be same as last decade. So I feel we shall see PE decline but not to 20-25 times. Please note that there are very few companies where you can trust management very easily. So not giving objective reply to your valid point, but let me say I do not know then to give wrong reply.
P.S.: We all are and would continue to remain student on market. Market do not like Maters. Please keep your enthusiasm and hunger for knowledge. That is definitely would take you on right path.

@KC1986
Very well summarisation of thread. Valid point about projecting segment wise growth to get more insight. However, given the segment include more than 100 products each, we would again end up with some industrial growth or GDP growth kind of factor to forecast growth. Not to discourage anyone but this is more of my limitation.

On second point, in my view they have unique and ease of usage product which give them real advantage and kind of monopoly in many products. Just try post it and other tape. Paste 20 times same of post it note and competitior note. After 4-5 attempt, the competitor product would loose stickiness. That is what I meant by ease of use or superior performance. Once used it sticks to user.

On third point, local manufacturing would result in lower cost of production. It would partially passed on to the customer which would make larger addressable market and have operating leverage and same margin. This is my understanding and it may be wrong.

Thanks everyone for your queries and valid point. My apology in case my comments are harsh.

Wish all a very happy 70 PE, my apology, happy Republic Day !!!