3M Reports In Line Second Quarter EPS of $1.91

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3M reported second-quarter EPS rose 12%, to $1.91, in line with consensus and our estimates. Sales of $8.1 billion and organic revenue growth of 4.8% were spot on expectations, though operating margin of 22.8% was slightly higher than expected. In contrast to the first quarter, 3M’s effective tax rate of 29.5% was slightly higher than expected and fully diluted share count of 665 million was slightly less than forecast, which along with better operating margins offset and enabled in-line EPS. Whereas 3M’s first-quarter results were characterized by a bit lower revenues offset by a lower-than-expected tax rate, an almost uncanny consistency (operating margin exceeded 20% for all businesses) was evident across all geographies and businesses this quarter.

The company left its 2014 guidance for EPS of $7.30-$7.55 and organic sales of 3%- 6% unchanged. Foreign exchange is expected to now be a $0.07-$0.08 headwind in 2014 (versus $0.05 or less) and the benefit from higher prices (raised mid-2013) is expected to diminish. Developing market organic sales (35% of total 3M sales) rose 7% (up from 5% in the prior quarter) while developed organic sales rose 4% (versus 4.5% in the prior quarter). For 2014, 3M believes emerging market sales should grow 6%-8%. Longer term, 3M believes developing can grow 8%-12%, while developed should average 2%-4%.

Operating profit margin of 22.8% was slightly ahead of our 22.6% forecast, with the largest upside coming from Electronics and Energy (reflecting restructuring of the business), where operating margins rose 292 basis points from a year earlier, and Safety and Graphics. 3M repurchased $1.4 billion of its shares (down from $1.7 billion in the prior quarter) but noted it now anticipates repurchasing $4.5 billion-$5.0 billion (gross) in 2014, up from $4.0 billion-$5.0 billion previously. We now assume net repurchases of $4.3 billion (versus $4.1 billion prior). Although emerging markets remain volatile and foreign currency will now likely affect sales by -1% for the year, 3M believes its decision in mid-2013 to aggressively increase prices (particularly in countries with the largest devaluations) is working well.

We retain our Market Perform rating with no change to our EPS estimates for 2014 of $7.55, but we increased our 2015 EPS estimate from $8.30 to $8.35. 3M’s best operating leverage is still likely to be found when emerging markets solidly rebound, but for now the company appears well on track to consistently deliver until this occurs. Based solely on higher market valuations, we are raising our 12-month price target to $145 (up from $137), assuming the shares trade at a 15% relative P/E premium to the overall market, based on our 2014 EPS estimate of $7.55 and FactSet’s estimated 2014 S&P 500 P/E of 16.7 times (up from 15.7 times previously).