3M's (MMM -0.28%) first-quarter earnings presentations left investors with more questions than answers. The numbers from the quarter were excellent, but management merely maintained its full-year guidance and warned investors about rising cost headwinds and margin pressure to come.
What are investors to make of it? Here's the lowdown.
3M first-quarter earnings and guidance
Total company organic year-over-year revenue growth was 8%, with adjusted operating margin up 170 basis points (where 100 basis points equal 1%) to 22.5%, and the business segment's adjusted operating income increasing 18.8%. That's strong performance, and ahead of what most Wall Street analysts had estimated for the quarter.
So why the negative reaction from the market? The answer lies in the fact that despite the excellent first quarter, management maintained full-year guidance and gave some negative-sounding commentary on the second quarter and full year. A summary of the points:
- Full-year earnings per share (EPS) are still expected to be $9.20-$9.70, with organic sales growth guidance also maintained at 3%-6%.
- Full-year EPS headwinds from increased raw materials and logistics costs are now expected to be $0.30-$0.50, compared to a previous estimate of $0.20 and an estimate of $0.10 at the start of the year.
- According to CFO Monish Patolawala on the earnings call, "we anticipate a second-quarter year-on-year operating margin headwind of 75 to 125 basis points from selling prices, net of higher raw materials and logistics costs."
Safety and industrial and transportation and electronics
It's a somewhat underwhelming outlook, given that 3M had such a good start to 2021 across all its segments.
The safety and industrial segment has enjoyed good growth since the pandemic started due to its respirator sales. Indeed, pandemic-related respirator demand contributed 6.4% of growth, compared to the 10.3% increase in the segment's growth.
Obviously, those tailwinds could turn into headwinds as the pandemic subsides, but the segment contains many other businesses with heavy exposure to an improving industrial economy. For example, industrial adhesives and tapes and roofing granules sales increased by double-digits in the quarter, and 3M's abrasives, electrical materials, and automotive aftermarkets offer the potential to continue to grow in 2021.
The other highly cyclical segment, transportation and electronics, reported organic growth of 9.8%. It's a great start to the year and at the top of management's full-year guidance for organic sales growth in the "low to high-single digits." Moreover, the segment is going to come up against some easy comparisons in the next three quarters.
Healthcare and consumer segments
The healthcare segment generated 9.3% organic growth. Just as with the safety and industrial segment, respirators provided a significant growth portion. In fact, the medical solutions business generated 46% of the segment sales in the quarter, and Patolawala said that "excluding respirators, organic growth in this business was down low-single digits due to the ongoing year-on-year impact of lower procedure volumes. "
While non-respirator sales were disappointing, as the pandemic subsides, non-COVID elective procedure volumes will improve, and 3M should see improvement in the future.
Finally, the consumer segment continues to see strong growth due to stay-at-home measures and social distancing, encouraging home improvement demand. In common with respirators, that's a tailwind that could turn into a headwind as the pandemic subsides. Still, the segment also sells stationery and office solutions, which will improve as the economy opens up.
What it all means to investors
Putting it all together, the glass-half-empty approach sees 3M as facing potential headwinds from an easing in the global pandemic, leading to slowing growth in respirator and home improvement sales. Meanwhile, increasing raw materials and logistics costs are eating into profits, and the outlook for automotive production (a key end market for 3M) remains uncertain due to the semiconductor shortage.
On the other hand, 3M has plenty of businesses with cyclical exposure to an improving economy. The company has just reported an excellent quarter but merely maintained full-year guidance. The cyclical businesses have the potential to offset potential weaknesses in the businesses that have benefited from the pandemic.
Is 3M a buy?
Frankly, it looks like management has taken a cautious approach to guidance, and it's closely fitted to the glass-half-empty approach outlined above. It's an approach that may prove too conservative. On that basis, and given the stock's 3% dividend yield and excellent free cash flow generation ($6.6 billion in 2020), the stock continues to look like a decent value.