By: Scott Davis
The late and great Brian Jellison, who put up Buffett-like returns while running Roper from 2001 until his passing 6+ months ago, had strong opinions about more than a few things. One of which being his general disliking of analysts, investment bankers, and Wall Street overall – he viewed us all as a tad dense. The Street’s infatuation with EBITDA was one of his chief complaints. Another was the classic definition of ROIC – which he generally believed only to be useful if using true cash generation in the numerator and then adding back accumulated depreciation to the capital base for the denominator. One of his notable complaints being that the market over-valued asset-intensive companies and under-valued the asset-light ones. Over much of his career that sure seemed to be the case. Hard to say so as much today though, given higher software valuations. The market finally caught up to Brian’s view it seems.
The point of the story is that nothing upset him more than Roper being compared to other industrials – in particular 3M. Industrials with big factories, high working capital needs, and pension and/or environmental tail risk. In fact, he would specifically call out 3M as the most glaring example of a company that just could not grow without outsized spending. The extent of R&D and capex spend required to drive GDP-type growth he felt was overlooked by investors. Versus his company that required almost no fixed asset investment, had positive working capital float, more focused R&D spend – largely software related – and generated sky-high incremental returns on a true cash/cash basis. We didn’t agree with every Brian Jellison opinion, but it’s hard to argue with the relative success of Roper vs. pretty much any industrial company one could name – including best-in-class comps like Danaher and Honeywell. Let alone more mortal industrials.
3M’s problem today is symbolic of the Jellison opinion. At its core, 3M is an excellent widget maker, best-in-class versus most others with enviable margins. But the investment spend required for each additional widget is high, and there’s an environmental liability tail that comes with owning traditional factory assets Jellison always warned about. Additionally, the ability to drive growth above GDP is a challenge that 3M has struggled to overcome for a long time. And to drive even GDP-type growth, 3M has had to increase its risk profile, largely meaning more Emerging Markets macro risk and FX risk.
To back up a bit, 3M’s historic core growth rates are not impressive, given the iconic brand and spend rates. In downcycles the company gets whipped around by sharp inventory corrections. In upcycles we get the bounce back that comes with being cyclical, but the follow-through growth fails to materialize. Trough to trough or peak to peak, 3M is just average. The numbers don’t lie: 3% average core growth in the last decade, 3% in the last 1, 3, and 5-year time periods – all below global GDP.
And that’s the 3M dilemma. It views itself as a growth company and spends heavily on pretty much everything to drive that agenda. But it doesn’t really grow. Which calls into question the entire 3M playbook. And the market is not fooled – the stock has had a rough time of late.