The only time 3M (MMM 0.50%) hogs the limelight is during its quarterly earnings releases -- the company otherwise works silently behind the scenes, only giving out intermittent dividend and product updates. This is why 3M's investor day, hosted on Nov. 15, was such an important event for shareholders. The last such event was in March 2016, and a lot has changed since, including investor perceptions about 3M.
3M shares led a solid rally for a couple of years until early 2018 when they started to lose steam. Thanks to macroeconomic concerns, a series of disappointing quarterly numbers, and the recent broader sell-off in industrial stocks, 3M is now down about 13% so far this year.
To know what lies ahead for 3M, look no further than its latest investor presentation. Management didn't just guide for 2019 but also outlined its financial targets for the next five years. Can this fresh five-year plan trigger another rally in 3M shares like the last one?
Why 3M lost favor with the market
Fiscal year 2018 has been a mixed bag for 3M so far from an operational standpoint.
| Metric | Nine months ended Sept. 30 2018 | Nine months ended Sept. 30 2017 | Year-Over-Year Change |
|---|---|---|---|
| Net sales | $24.8 billion | $23.7 billion | 4.6% |
| Operating income | $5.4 billion | $5.9 billion | (8.5%) |
| Net income | $4 billion | $4.3 billion | (7%) |
| Free cash flow (FCF) |
$3.1 billion | $3.4 billion | (9%) |
| GAAP diluted earnings per share (EPS) | $6.61 | $7.08 | (6.6%) |
| FCF per share | $5.18 | $5.66 | (8.5%) |
| Dividend per share | $4.08 | $3.525 | 15.7% |
Data source: 3M financials.
3M entered 2018 on a strong note, having grown its sales by 5% in fiscal 2017. Its EPS, however, slid roughly 3% to $7.93, but that was primarily because of the tax reforms that came into effect under The Tax Cuts and Jobs Act late last year. Apart from that, 3M's adjusted earnings grew 12.4% versus 2016. Management also upgraded its earnings outlook for FY 2018 to $10.20-$10.70 per share.
Unfortunately, demand from key end markets especially electronics, energy, and healthcare hasn't played out as expected, forcing 3M to roll back its FY 2018 GAAP EPS guidance for the second time this year in October to $8.78-$8.93. Meanwhile, the trade war between the U.S. and China, tariff headwinds, foreign exchange fluctuations, and the volatility in the broader market has further fueled skepticism about 3M's growth.
3M, the maker of Post-it Notes, is optimistic about its future. But should you be? Image source: Getty Images.
That 3M is cautious about growth at least in the near term also reflects in its sales outlook for FY 2019:
- Total sales growth: 1%-3%
- Organic local currency sales growth: 2%-4%
- GAAP EPS: $10.60-$11.05
- Adjusted EPS growth: 7%-11%
Comparatively, 3M's financial goals for the next five years through 2023 are pretty encouraging.
- Organic local-currency sales growth: 3%-5%
- EPS growth: 8%-11%
- Return on invested capital: 20%
- Free cash flow conversion: 100%
So where does 3M expect its earnings growth to come from?
3M's road map to 2023
For a conglomerate like 3M, there's always a diverse mix of end markets that contribute to its top-line growth. Healthcare, in particular, has been a drag of late, so it's interesting that management expects this segment to grow the fastest in the next five years.
| Segment | Organic Local-Currency Growth Target |
|---|---|
| Healthcare | 4%-6% |
| Safety and graphics | 3%-6% |
| Industrial | 3%-5% |
| Electronics and energy | 2%-6% |
| Consumer | 2%-4% |
Data source: 3M.
Overall, organic sales are expected to add 3 to 5 full percentage points, mergers and acquisitions 1 to 3 percentage points, and margin expansion 2 to 3 percentage points to 3M's projected EPS growth of 8%-11%. The rest of it should come from non-operational factors such as taxes and share repurchases.
3M has identified a dozen "priority" areas to push organic growth. It's therefore likely that most of the company's targeted research and development (R&D) expenditure of around 6% of sales will go toward these 12 platforms in the coming years.
Image source: 3M presentation.
In between, 3M aims to make meaningful acquisitions to grow its portfolio. 3M isn't really an acquisitive company, and its last two major acquisitions were both in safety and graphics business. Interestingly, at the just concluded Credit Suisse's 6th Annual Industrials Conference, CEO Michael Roman hinted that the company is actively looking for more acquisitions in safety and graphics. Healthcare and industrial are other areas it's targeting.
So what does this 5-year plan mean for 3M stock?
Two things stand out in 3M's new five-year plan: It remains an R&D-focused company and is visibly directing resources toward newer potential markets. At the same time, its traditional consumer business, which primarily includes products under flagship brands like Post-it, Scotch, and Filtrete, is finding growth hard to come by. It's therefore imperative that management delivers on its growth targets for other businesses to convince shareholders of its long-term story.
From a financials perspective, 3M shouldn't give a reason to complain as management expects to generate nearly $55 billion-$65 billion in operating cash flow through 2023 and not raise more than $15 billion in net debt during the period to fund growth. That should also leave enough leg room for the company to continue raising dividends and remain a top Dividend King.
Today, 3M stock may not look cheap at a price-to-free-cash flow of 27 times, but I'd trust management with its growth-oriented action plan and commitment to shareholders and believe patient investors will be richly rewarded five years from now.
