What happened

It's the same old story for 3M (NYSE:MMM) that's been playing out for quite some time now: An earnings report that quashes investor hopes of better days ahead and sends the stock crashing. 3M shares declined 10.1% in the month of January, according to data from S&P Global Market Intelligence, with almost the entire drop coming after Jan. 27 following the company's fourth-quarter and 2019 earnings release. 

This time though, the quarter was messier than ever and management's outlook grim enough for investors to shrug off 3M's desperate restructuring efforts to return to growth. 

So what

While 3M's Q4 sales increased 2.1% year over year, its full-year sales dropped 1.9%. That wasn't really unexpected given the ongoing challenges the maker of diversified products including Post-it Notes and Scotch tape has been facing for several quarters. But one Q4 number caught investors off guard: earnings per share of $1.66 under generally accepted accounting principles (GAAP), including charges of $0.49 per share "from items not in prior guidance." That profit number represented a 27% drop from Q4 2018.

Sticky notes with question marks drawn on them.

Image source: Getty Images.

So what were those items that hit 3M so hard but management didn't see coming? There were two:

  • a pre-tax restructuring charge of $0.20 per share 
  • a pre-tax litigation charge of $0.29 per share

To be fair, 3M kicked off a restructuring program mid-last year, starting off by moving from five business groups to four. What's surprising is how management couldn't foresee restructuring charges of such magnitude for Q4. 3M is now laying off 1,500 workers as part of its "transformational journey," as management calls it. The company expects the move to save it $40 million to $50 million in pre-tax savings this year.

The litigation charge is even more perturbing. It's well known to the market by now that 3M is staring at a potentially significant liability under the several lawsuits for its involvement in the PFAS contamination issue. Management, however, has tried really hard to downplay the risks in recent quarters, which is why the company booking such a big charge in Q4 was a nasty shock. CEO Mike Roman's conviction that 3M is well positioned to improve "performance, return to growth and deliver a successful 2020" failed to convince the market.

Now what

3M expects organic local-currency sales growth of flat to 2% and GAAP earnings of $9.30 to $9.75 per share in 2020. That's a pretty impressive earnings forecast even when compared to 3M's adjusted 2019 earnings (excluding substantial one-time charges) of $9.10 per share. 3M expects the bulk of the growth to come from restructuring, which is encouraging. 

Two things, however, could dent that forecast: further potential litigation charges, and unfavorable developments in China, an important market for 3M. Even before the coronavirus began spreading, 3M was looking at a "sluggish start to China in the first quarter," Roman revealed during 3M's Q4 earnings conference call. With the coronavirus outbreak assuming bigger proportions by the day, the first quarter could be worse for 3M. 

If there's any respite for shareholders, it's in 3M's dividends. The company is confident it will generate nearly as much in free cash flow as net income in 2020 and return a large chunk of it to shareholders in the form of dividends, thereby remaining a good dividend stock to own.