Morning Star
January 21, 2009

Erik Kobayashi-Solomon: Hi I’m Erik Kobayashi-Solomon, Co-editor of Option Investor from Morning Star. I’m here with Adam Fleck, Senior Equity Analyst on the Industrial Statement Morning Star.

Adam, as you know; back in November I recommended to our readers to sell puts on 3M. Struck at $55.00 a share, giving them a by-price of less then 50 bucks a share and yesterday on inauguration day the price actually slipped the lower strike price. So, I just wanted to talk to you a little bit about the kind of sources of uncertainty at 3M.

Adam Fleck: Sure.

Erik Kobayashi-Solomon: So one of the things that I had mentioned in the original write up was the optical films business and the electronics business. Can you give a little more color on those businesses?

Adam Fleck: Absolutely. The optical films business certainly has been a source of uncertainty here. The problem is if you look at the optical film business it’s not a large part of 3M’s business in 2007 the displaying graphic segment was about 16% of sales, optical films was about half of that so your talking of less than 10% of their sales. However there has been a major concern with how the dynamic has shook out for 3M’s demand on that market. The major concern has been the film that 3M produces for LCD televisions—this is a film that is quality enhancing that is for top line LCD televisions. And what 3M didn’t bet on was that consumers were very quickly apt to sacrifice quality for price and you had a company like Visio that quickly shot to the number one market share.

Erik Kobayashi-Solomon: I was just going to say this is a Visio effect I think.

Adam Fleck: Absolutely, absolutely and Visio doesn’t use 3M’s film. 3M tried to defend its position and completely lost its market share. However, going forward, we do not think that has a huge impact on the stock price for us. It does not hold a whole lot of value for us.

Erik Kobayashi-Solomon: What’s happening with their optical films business right now? Do you think it has brought them at this point? Is there any chance for them to turn it around?

Adam Fleck: There is. I think it has brought them. I think 3M’s market share a little has fallen dramatically. It’s a pretty stable position at this point and there is some opportunity there for power conscious consumers, energy conscious consumers who want to use 3M’s film and buy televisions that use less light bulbs because it’s able to spread the light out more effectively.

Erik Kobayashi-Solomon: So kind of the “Obama Green Effect.”

Adam Fleck: Perhaps, perhaps.

Erik Kobayashi-Solomon: We get a little pick up from that.

Adam Fleck: Absolutely. Now you elude it to off course the electronics market as well.

Erik Kobayashi-Solomon: Right.

Adam Fleck: Similar dynamic here. This is a 3M’s smallest segment as their electro communications segment. About 40% of that is their electronics business and what this is, is they sell to end market such as cell phones, hard drives, printers. It’s actually held up pretty well this year sales to the first 9 months for about 6% operating profits were up about 11% so it’s doing well so far and I think part of that is the fact that this is their segment which has the least US exposure—only about 30% of sales here are domestic.

Erik Kobayashi-Solomon: I see. So, it’s a minimal exposure to kind of US problem.

Adam Fleck: Absolutely. There is concern off course with the Global Recession that’s consumer demand driven. There is off course the problem that you could have less consumer spending on these types of electronics that are more discretionary in nature and are ready to be seeing in a bit of weakness and differences or ink Gen market.

Erik Kobayashi-Solomon: The rest of 3M’s portfolio. The reason that really attracted me is because it’s mainly throw away stuff and stuff that they get good margins on. How do you see the economic weakness kind of affecting that part of the business?
Adam Fleck: Absolutely. It definitely is more essential, disposable material especially when you look through out their abrasive segment when you look through out their health care segment, their safety segment. These are products that people are going to use and dispose off and renew no matter what the economic condition is. However, you did allude to the fact that off course there is opportunity specifically for a company like 3M. Already for instance, they have been doing some volt on acquisitions through out the year and truly those seven enough through ’08 they’ve been adding to their court conference season safety and abrasives.

Erik Kobayashi-Solomon: And they have the balance sheet to support that?

Adam Fleck: Absolutely. They have a very clean balance sheet and they have a billion and a half revolving credit lines outstanding that they will be able to continue that I think.

Erik Kobayashi-Solomon: But you know this actually leads me to one of the questions that I had looking at the financials myself and that is; they’ve always prided themselves on organic growth but lately, it seems like there having to acquire sales growth. Is that a fair complaint about their business? Is this helping or hurting them do you think?

Adam Fleck: I think it’s definitely helping. For one, they are continuing to spend on their research development cost. Continuing about 5 to 6 % of sales and they look to do that going forward as well. Not to mention if you are look at the invested capital which as you know as a huge metric for Morning Star, it’s actually improved in the last ten years to over 30% from about 22% as sales has increased about 50%.

Erik Kobayashi-Solomon: I see.

Adam Fleck: So it’s definitely been successful for them.

Erik Kobayashi-Solomon: I see. So now we are looking at 3M right around our $55.00 strike and that means we are buying their stock if we are assigned these options for something like 49 and a half something like that. Right about there, what kind of dividend yield are we getting? How much are they paying in dividends?

Adam Fleck: Well it’s about $2.00 a share in dividends you are looking upwards of 5%.

Erik Kobayashi-Solomon: 5% something like that.

Adam Fleck: Yeah. And we have an $85.00 fair value on this stock. So we definitely think its good deal for investors.

Erik Kobayashi-Solomon: Right. Well Adam, thanks a lot I appreciate you for kind of walking us through and giving us little color.

Adam Fleck: Absolutely, anytime Erik.

Erik Kobayashi-Solomon: Thanks very much and please continue to the Option Investor site. We have got lots of great investment ideas for up of down markets. I’m Erik Kobayashi-Solomon. Thanks for watching.