That there are a lot of moving parts to 3M Company (NYSE:MMM) was never as apparent as it is now. Exactly three months ago, the industrials conglomerate delivered a solid set of quarterly numbers followed by an outlook upgrade. Yet those who believed that pace of growth wasn't sustainable must be patting themselves on the back after 3M released its third-quarter numbers on Oct. 23.
So what went wrong these past few months that has forced 3M management to roll back its earnings guidance for the full year? Let's find out.
3M results: The raw numbers
From 3M's key numbers in the table below, it's evident that the company continues to churn out strong profits and cash flows. What's notable, though, is decelerating sales, which raise two pertinent questions: Why are 3M's sales falling, and what's boosting its bottom line?
|Metric||Q3 2018||Q3 2017||Year-Over-Year Change|
|Sales||$8.15 billion||$8.17 billion||(0.2%)|
|Net income||$1.54 billion||$1.43 billion||7.7%|
|GAAP earnings per share (diluted)||$2.58||$2.33||10.7%|
|Free cash flow||$1.76 billion||$1.43 billion||23%|
3M's Q3 presentation reveals where things went wrong this quarter. Three factors stood out:
- Low-single-digit or negative organic local-currency (organic volume plus price) growth across all business segments.
- Weakness in all markets except Asia-Pacific, which clocked 3% organic volume growth.
- Foreign exchange headwinds.
3M is a hugely diversified company, manufacturing more than 60,000 products under several world-renowned brands, including Post-it notes and Scotch adhesive tape. So there will almost always be pockets of weakness in its portfolio to offset strength elsewhere.
For instance, 3M's total organic local-currency sales grew 1.3% year over year in Q3, but foreign currency headwinds chipped nearly 1.7% off its top line. Even within segments, the disparity in end markets was visible. So within industrials, if advanced materials clocked double-digit organic growth, a decline in automotive aftermarket sales hit margins.
Overall, though, this was one of 3M's weakest quarters in recent times in terms of sales volumes, as most end markets faced headwinds. Healthcare in particular turned out to be a surprising laggard with a sharp 25% drop in sales from drug delivery business.
|Business Segment||Organic Local-Currency Sales Growth||Total Sales Growth|
|Safety and graphics||2.2%||Flat|
|Electronics and energy||(2%)||(3.4%)|
Note that total sales include the impact of acquisitions, divestitures, and foreign currency translation.
So what drove 3M's EPS higher despite lower sales? While many believe the company is shoring up its profit numbers through the boatload of shares it's repurchasing, share buybacks contributed just about $0.06 to its Q3 GAAP EPS. Instead, U.S. tax reform and the resultant lower tax rate was a major contributor, adding $0.22 to GAAP EPS.
What management had to say
Management, unsurprisingly, said little about the company's dismal quarterly performance. The company's earnings conference call (click here to access 3M's full third-quarter earnings call transcript) revealed greater details about 3M's plans to bolster growth in this challenging business environment. CEO Mike Roman said:
Looking at the remainder of 2018 and beyond, we know there is a lot more we can and will do to deliver for our customers and shareholders. Going forward, we are focused on driving growth, being relentless in putting our customers first, and continuing to transform 3M to deliver greater productivity. This means we will continue to work to optimize our portfolio, prioritizing resources to our most attractive opportunities.
We will strengthen our innovation model and continue to invest in research and development, which enables us to create unique solutions that advance, enhance, and improve outcomes for our customers. In addition, we'll continue to invest in high-growth, high-value product platforms such as automotive electrification, advanced wound care, and data centers.
By now, it's clear that macro (and not company-specific) headwinds are posing a challenge for 3M. It's therefore not surprising that management is focused on driving growth through innovation along with research and development, especially in new-age, high-potential areas like electric cars and data centers. For now, 3M's expectations for the immediate future remain muted, as evident in its latest full-year guidance.
For full-year 2018, 3M now expects organic growth to come in at the lower end of its previously guided range of 3% to 4%. It also expects GAAP EPS of $8.78 to $8.93, versus $9.08 to $9.38, as currency fluctuations and rising input costs could pressure margins. Foreign exchange will always be among 3M's biggest risks, as nearly 60% of its sales originate outside the U.S.
That EPS guidance still represents nearly 12% growth at the midpoint from 2017, but we already know that sales have little to do with it. What investors need to watch for now is whether this trend is here to stay. Set up a Post-it reminder for Nov. 15: That's the day you could get some answers as 3M hosts its Investor Day and lays out its growth plans and financial goals for the next five years.