3M: We Downgrade Moat Rating to Narrow From Wide

We reduced our 3M MMM fair value estimate to $123 from $131, due to the moat downgrade to narrow from wide. We think that 3M’s basic moat framework remains valid. Specifically, 3M’s centralized research and development capabilities should protect excess returns. However, that argument is far weaker than it used to be. Consequently, we’re less confident in 3M’s moat durability.

Some of 3M’s businesses face eroding competitive advantages. For instance, oral care faces significant disruption from greater customer buying power. Others, like health information systems, face large competitors far more embedded in customer systems. Still, other businesses like electronics face likely secular decline, while others, like electrical materials, simply sell solutions that occupy a less attractive portion of the supply chain.

However, 3M’s overall R&D spending isn’t just decreasing. That spending is also yielding far fewer benefits, both in terms of organic growth and gross profitability. Over the past 30 years, 3M has steadily spent less on R&D as a percentage of sales. In the early 1990s, R&D as a percentage of sales exceeded 9%, but as of 2023, it is now less than 6%. Yet, organic growth over the most recent six-year cycle slowed by approximately 180 basis points compared with the prior period.

In turn, 3M has had to tap larger acquisition targets to maintain its sales growth over the past decade. However, these types of capital investments are more costly than organic alternatives. 3M’s returns on invested capital including goodwill, therefore, have steadily declined.