3M May Get Leverage From Inventory Restocking

A little additional demand could go a long way toward reviving profits at 3M Co. (MMM), the diversified industrial group.

As much as two-thirds of the 3M's sales are tied to industrial staples, products such as adhesives, coatings, films and packaging materials that are consumed in larger quantities whenever companies increase their production.

The stock reached a 52-week high at the end of last week, pushing its market value back above $50 billion and ranking it second among industrials to only General Electric Co. (GE).

The Minnesota-based company makes thousands of products, ranging from Scotch tape and Post-It Notes to furnace filters and medical supplies. The company is considered an indicator of market conditions across a variety of consumer and industrial sectors.

Analysts say even modest levels of inventory restocking by manufacturers this fall will boost 3M's income and could usher in more substantial and sustained improvement in end-market demand during 2010.

"Any pickup is going to be seen quickly" at 3M, said Adam Fleck, an analyst for Morningstar Inc. "They're going to get a really nice pop in the fourth quarter and the first quarter of 2010."

Illinois Tool Works Inc. (ITW), another bellwether, reported a sequential improvement in quarterly revenue Monday, though all of its business segments remain sharply lower than a year ago.

After missing Wall Street analysts' earnings estimates for two straight quarters, 3M reported higher-than-anticipated earnings and revenue for the second quarter ended June 30.

The company declined to make executives available for an interview with Dow Jones Newswires. But in comments to Wall Street analysts last month, Chairman and Chief Executive George Buckley warned that the dimensions of the improving demand remain unclear.

Rising raw material prices and anemic consumer spending could keep sales and profit under pressure. "It's too early and too uncertain to celebrate some kind of recovery," Buckley said.

The company was caught in Monday's broad market sell-off, recently down 1.8% at $70.03, though held firmer than General Electric or Caterpillar Inc. (CAT), another closely watched guide to broader investor confidence in an economic recovery.

Some analysts contend that 3M could support a higher price based on the company's ability to generate higher margins. In the second quarter, 3M's pre-tax operating margin rose to 22.6% from 21% a year earlier, despite that sales in the quarter dropped 15%.

Besides aggressively cutting its work force and other overhead costs in recent quarters, 3M's margins traditionally have benefited from the company's knack for lowering costs by applying its products and processes across multiple business lines.

An estimated 80% of 3M's sales come from items made with ingredients, technologies and assembly processes provided by the company, according to a recent report from Jefferies & Co.

"What differentiates 3M is its ability to layer up to dozen technologies on a product and consequently tailor it to a specific market niche," said Jefferies analyst Laurence Alexander.

-By Bob Tita, Dow Jones Newswires; 312-750-4129; [e-mail]