Investors in 3M Company (NYSE:MMM) weren't too happy when Illinois Tool Works (NYSE:ITW) slashed its full-year outlook a couple of days ago. Both companies serve several common end markets, and just months ago, 3M had downgraded its fiscal 2018 guidance, giving critics plenty of fodder

3M, however, knows better than to disappoint its shareholders. The industrials conglomerate not only reported solid numbers, including record sales, for its second quarter on the morning of July 24 but also upgraded its full-year earnings outlook. 3M's new CEO, Michael Roman, also has something nice to say to his stakeholders.

3M results: The raw numbers

Looking at the table below, which provides a snapshot of the key numbers from 3M's second-quarter earnings report, would you believe that the stock actually nosedived right after the earnings release? I'll tell you why later (and you can have a good laugh at that) but, first, the real numbers.

Metric Q2 2018 Q2 2017 Year-Over-Year Change
Sales $8.4 billion $7.8 billion 7.7%
Net income $1.86 billion $1.58 billion 17.7%
GAAP earnings per share (diluted) $3.07 $2.58 19%
Free cash flow  $1.53 billion $1.34 billion 14.2%
Operating margin 28.6% 27.6% 1 percentage point

Data source: 3M. Table by author. 

There's a lot to like here. Pretty much like its last quarter, 3M's Q2 sales hit all-time highs with organic sales rising 5.6%, backed by strong growth across all its business segments and geographic markets.

What happened with 3M this quarter?

Breaking up 3M's Q2 sales reveals a common theme that's stretched for some quarters now: a standout performance from safety and graphics but slow demand for electronics.

Business Segment Organic Local-Currency Sales Growth Total Sales Growth
Safety and graphics 8.5% 15.8%
Industrial 5.7% 6.8%
Healthcare 3.8% 4.9%
Consumer 4.3% 4.6%
Electronics and energy 5.2% 3.6%

Data source: 3M. Table by author.

Nearly 40% of that growth in safety and graphics sales came from acquisitions, primarily Scott Safety, which 3M acquired from Johnson Controls late last year. On the other hand, a portfolio churn in its electronics and energy division took a bite off sales: 3M sold its communication markets business last quarter to Corning in a deal that earned 3M a tidy divestiture gain of $494 million.

A cork board with smiley post-it notes.

Post-it manufacturer 3M's operational performance should make investors happy. Image source: Getty Images.

Overall, 3M's industrials segment, which primarily comprises advanced materials, adhesives, abrasives, purification, and aftermarket, was the largest contributor to its sales and operating profit.

Here are a couple of other notable highlights from the quarter:

  • On a geographic basis, China/Hong Kong clocked the highest sales growth of 12% during the quarter, with Canada coming in second with 8% growth in sales.
  • Thanks to 3M's stronger footprint in Asia-Pacific and Europe, foreign currency conversions added a percentage point to its total sales growth. Comparatively, currency was a major headwind for Illinois Tool Works.
  • 3M returned $2.4 billion to shareholders in the form of dividends and share repurchases.

What management had to say

CEO Mike Roman, who took over the reins from Inge Thulin this month -- Thulin is now the  executive chairman on the 3M board -- was excited about 3M's quarterly performance and is equally optimistic about the future. He said:

Going forward, we will continue to prioritize 3M's portfolio, strengthen our innovation capabilities and accelerate our transformation, while developing our people. The 3M Playbook is working and we're just getting started. We are well positioned to deliver even greater value for our customers and shareholders in 2018 and beyond.

During 3M's earnings call conference (you can access the full 3M second-quarter call transcript here), Roman further expressed how keen he is to unlock greater value from the company's portfolio. "It's about targeting where we go with M&A. It's also about reviewing our businesses as we go. I see that as very much part of our future for value creation opportunity and it's a priority for me as I step into the role", he said.

In other words, investors can expect both, acquisitions and divestitures, from 3M in coming months. One area Roman said he'd be looking at is "high-growth opportunities" in electronics and energy, including "automotive electrification, data centers, and semi-conductor fabrication." That sounds like an interesting proposition.

Looking forward

Thanks primarily to the gain from the communication markets divestiture, 3M upgraded its GAAP EPS guidance to $9.08-$9.38 from $8.68-$9.03 for the full year. Mr. Market, however, stuck to the tiny "downgrade" of 0.5% at the midpoint in 3M's adjusted EPS and sent the stock down initially, only to (thankfully) regain his senses later. Just so you know, this downgrade is the result of lost sales from the divested business, which barely matters.

3M sees its full-year organic local-currency sales growing 3%-4% and is committed to converting 90% to 100% of net income into FCF, which could mean anything between $4.9 billion-$5.7 billion in FCF this year. That should make income investors happy as well.