3M (MMM 0.41%) investors will have to be patient. That's the key takeaway from 3M management's recent investor presentations. On the one hand, the stock's underlying long-term investment case remains intact. On the other, the company faces some near-term headwinds, leading to disappointment in 2021. Let's take a closer look at what's going on and what you need to know if you're considering buying the stock.
Auto production constraints could hurt 3M in 2021. Image source: Getty Images.
An underperforming company
Investors in 3M hope that CEO Mike Roman's restructuring initiatives will turn around its operational performance. In recent years, 3M's operating margin has been under pressure and the problems couldn't entirely be blamed on weakness in the industrial economy, as much of the disappointment came in the less economically sensitive healthcare and consumer segments.
Data by YCharts
Operational restructuring
In response to the company's poor performance, Roman has set about restructuring the company. Among the changes, 3M now has four business segments instead of five while also streamlining the company for growth. Management has divested underperforming businesses (one example being its drug delivery business for $650 million in 2020), and some market participants believe it could sell its food safety business.
Meanwhile as part of its efforts to spur growth in the healthcare segment, 3M bought M*Modal's technology business (artificial intelligence systems for healthcare physicians) for $1 billion, and Acelity (advanced wound care) for $6.7 billion. Both deals were completed in 2019.
Administrative changes
3M's management is making operational changes, and equally important, it's making organizational changes as well. A new business model has been in place since January 2020. Under the new model, business groups are now run globally, with the units running their own strategy and making their own capital allocation decisions. This is opposed to the previous model, where the businesses operated on a country basis.
Roman and CFO Monish Patolawala have cited the administrative changes as instrumental in driving 3M's future growth.
The investment case for 3M
The stock's investment case is that the restructuring actions will be successful. Investors can also feel optimistic because 3M continues to generate bundles of free cash flow (FCF) that will give management the financial firepower to enact further changes or buy businesses. The company's price-to-FCF valuation is now looking very attractive.
Data by YCharts
Guidance for 2021
Investors are hoping the fruits of management's actions start coming through in 2021. Simultaneously, the industrial economy's recovery is likely to lead to a growth pickup. Here's a summary of management's guidance given in January. Note that the more economy-aligned segments (safety and industrial and transportation and electronics) have stronger growth outlooks.
| 3M |
Full-Year 2021 Outlook |
|---|---|
|
Safety & Industrial organic sales growth |
Mid-single digits |
|
Transportation & Electronics organic sales growth |
Low- to high-single digits |
|
Health Care organic sales growth |
Low- to mid-single digits |
|
Consumer organic sales growth |
Low- to mid-single digits |
|
Total organic sales growth |
3%-6% |
|
Earnings per share |
$9.20-$9.70 |
Data source: 3M presentations.
Near-term headwinds brewing
Unfortunately, 3M faces some near-term headwinds. There are three things to focus on:
First, constraints in automotive vehicle production due to a shortage of semiconductors used in cars threaten 3M's sales in its safety and industrial and transportation and electronics segments.
Second, rising raw material costs -- Patolawala cited ethylene and polypropylene costs -- mean that management now expects a $0.20 EPS headwind in 2021 compared to a previous estimate of $0.10.
Pellets for plastics production. The rising cost of raw materials is impacting 3M's costs. Image source: Getty Images.
Third, management said that elective health procedures dipped in January due to the pandemic, so don't be surprised if the first-quarter healthcare segment numbers are a little weak.
All told, it looks like 3M could have a slightly disappointing start to the year, and the fact that management hasn't given specific guidance for the first quarter means it's tough to predict what will happen.
What it means for investors
Beyond the first quarter, investors still have reason to feel optimistic. The semiconductor shortage can be rectified by chip manufacturers and management said elective procedures are already coming back. Meanwhile, the EPS headwind increase from raw material prices is only $0.10 compared to a full-year EPS outlook of $9.20-$9.70.
As such, the long-term investment case is still intact. However, there's some cause for caution about the first quarter, and it's going to take time for the restructuring actions to fully show up in the earnings numbers. Patience is required.
