The continued poor stock performance of 3M (MMM +1.25%) suggests investors are starting to lose patience with the company. The company's latest investor presentation saw management walking down the full-year guidance it had given at the end of October. As such, the stock is even falling off of value investors' radars and increasingly becoming an option only for dividend investors.
Let's take a closer look at what's happening and whether 3M has investment potential left in it.
What happened
3M CEO Mike Roman and CFO Monish Patolawala presented at a Credit Suisse industrials conference in early December. They promptly told investors that organic sales growth in the fourth quarter would come in the "bottom half" of the implied growth range of zero to negative 2%.
3M has been negatively impacted by a slowdown in automotive production. Image source: Getty Images.
It's never good news when a company lowers sales estimates, but 3M's update was particularly frustrating for investors. There are three reasons why:
First, the walking back of sales guidance comes after management upgraded full-year organic sales growth guidance at the end of October during its third-quarter earnings presentation. Going into the third quarter, full-year organic sales growth stood at 6% to 9%, but management saw fit to raise the low end of the range to 8%-9%, even as it lowered full-year earnings guidance to $9.70-$9.90 from $9.70 to $10.10.
Given that implied fourth-quarter guidance has been lowered, it's reasonable for investors to downgrade expectations for earnings growth. There's also the question of why Patolawala lowered expectations a few weeks after raising them.
Second, it's no secret that investors are closely watching 3M's margin performance for clues as to whether its restructuring activities are producing operational improvements. Granted, this is a lot harder to judge during the pandemic, but Patolawala previously outlined the importance of volume growth to 3M's margin expansion. Given that sales growth will be weaker than previously expected, 3M's fourth-quarter margin will likely be under even more pressure.
Third, management noted that it continued to see supply chain shortages and high raw material costs. In other words, cost pressures will increase in the fourth quarter. As a result, 3M aims to increase pricing to make the difference between price and raw material costs neutral to margin. Patolawala was asked about pricing at the conference, only to reply that investors should "wait and see" what pricing 3M would get at the end of the quarter.
What it all means
The disappointing pricing commentary and the fact that 3M hasn't been able to offset cost increases with pricing action call into question the company's business model and/or the ability of the company to execute it. For reference, 3M prides itself on investing heavily in research and development to create differentiated products that command pricing power. Unfortunately, that pricing power doesn't appear to be evident right now.
Moreover, management has taken substantive restructuring actions to improve performance in recent years. Indeed, on the third-quarter earnings call, Patolawala told investors that restructuring charges in 2021 will be $300 million to $325 million compared to previous guidance for $250 million to $300 million.
Image source: Getty Images.
In addition, 3M's management has restructured how its businesses are run (business groups are now run globally rather than through an overarching country basis), and the healthcare segment was restructured through multibillion-dollar acquisitions and divestitures.
As yet, none of these restructuring actions have resulted in a discernible improvement in growth or margin.
A more positive take
That said, it's hard to be too critical of management during a challenging trading period. Furthermore, Patolawala did talk of the probability of an improved volume growth environment, pricing actions kicking in, a moderating raw material cost, and the benefits of the restructuring actions flowing through in the future. All of those factors point to margin expansion down the line.
Furthermore, 3M's stock currently has a dividend yield of 3.5%, and it's well covered by free cash flow. As a result, the stock remains a good option for income-seeking investors.
A stock to buy?
Ultimately, it depends on your investment profile. If you are looking for a relatively safe income stream, 3M stock is a useful purchase. However, the underwhelming operational performance and disappointing guidance will concern value investors who like to see some evidence of improvement before buying. For those investors, it makes sense to wait and see what 3M reports in its subsequent earnings releases and what kind of margin expansion is forecast for 2022.
