First Quarter 2016

The most recent quarter yielded more volatility in both North American and global equity markets. Despite steady growth in the United States, Western Europe and China, equity markets remain under the influence of short-term traders, who react to daily news stories, while ignoring long-term fundamentals.

Our investment approach focuses on companies, not stock markets. The most critical element of our approach is to get out of our office and meet with the managements of companies that we either own, or are considering for purchase. In this regard, we have been quite busy over the past five months.

In the technology sector, we have visited Microsoft, Intel, and MDA. In the energy and resources area, we have conducted management interviews with Vermilion, Pembina Pipeline and Enbridge. Our most active research has been in the consumer staples and consumer discretionary sectors, where we have met with Nestle, Colgate-Palmolive, Walt Disney, Costco, Proctor & Gamble, Diageo, General Mills, McCormick, Reckitt Benckiser, Clorox and Ingredion. We have also been to see International Flavours and Fragrances (IFF) and Givaudan in the materials sector as well as 3M in the industrials area.

In January, we wrote to you about the importance of innovation, and its crucial role in value creation. Our visit to see 3M (formerly the Minnesota Mining and Manufacturing Company) in St. Paul, Minnesota last month further reinforced this belief. We have owned 3M shares for our clients for well over a decade and it has been one of our best performers.

3M is a major U.S. based industrial company with a market capitalization of over $US 100 billion and $US 30 billion in annual revenue. Founded in 1902 as a mining company, it failed to develop its initial mining venture but survived to evolve into a tool maker for the mining industry. From these humble beginnings, 3M has evolved into a truly global industrial powerhouse. With a philosophy deeply embedded in science, innovation and technology, 3M now sells over 50,000 products in 70 countries. Its product lines spring from 47 separate technology platforms. A testament to its long history of innovation, the company currently holds over 105,000 patents, a truly staggering level. Employing almost 90,000 people, 3M is managed through five different business units: Health Care, Safety & Graphics, Industrial, Electronics & Energy, and International. Many of the company’s products are well known to end consumers: Scotch Tape, Post-It Notes, and Thinsulate. However, 3M is mostly a vast supplier of products which are used in other company’s end products.

A company like 3M is not easy to manage. To succeed, it must work closely with its customers and anticipate their needs. In order to meet these needs; it spends close to $2 billion a year on pure R&D, as well as another $1.5 billion a year on capital expenditures to further develop its productive capacity.

While 3M is an impressive company from a technology and innovation stand point, it is also well managed financially. Over the next five years, management anticipates that its earnings per share will grow 8% to 11% annually, revenues will grow 2% to 5% per year, and the return on invested capital will average 20%.

Central to our analytic approach is a focus on operating cash flow growth and wise allocation of free cash flow. 3M has delivered on this front for many years, and is expected to pay another $14 to $15 billion in dividends to its shareholders between now and 2020.

While equity markets may be volatile, successful companies like 3M will continue to deliver consistently to their shareholders over time. Steady performance like this is a result of superior management, focus on innovation, and adherence to a rock solid business philosophy.

While 3M is a gem, it is not unique. Our portfolios hold many other companies with similar attributes – strong revenue growth, expanding margins and high quality, stable earnings and cash-flows. Our research will continue to monitor these investments to ensure they continue to deliver superior growth and to look for new companies for your portfolio.



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