The market sell-off has created buying opportunities in many stocks, but is industrial giant 3M (MMM -0.06%) one of them? The stock is down 16% on the year at writing, and the stock currently yields a dividend of 3.9%. So is the dip enough to make the stock a buy? Here's the lowdown.
What happened to 3M?
To understand where 3M is heading, you have to know where it's come from. It's fair to say that 3M has had a difficult few years. Since 2018, the stock has been down 38% compared to a 65% rise in the S&P 500. The underperformance reflects the company's failure to meet guidance in recent years.
As a consequence of a series of disappointing earnings, management is engaged in an ongoing process of restructuring the company. CEO Mike Roman and CFO Monish Patolawala have actively restructured the company's operational structure. In addition, management has made substantive acquisitions and divestitures (notably in healthcare) to turn around performance in the last couple of years.
3M in 2022
Going into the fiscal year, it's clear that investors want to see hard evidence of operational improvements in its metrics, notably on profit margins. If 3M can convince investors it will generate future margin expansion and revenue growth, the market might positively revalue the stock, leading to significant share price expansion.
That's something management believes will happen, and the full-year 2022 guidance outlined at its investor meeting in mid-February helps support that view. Here are some highlights:
- Organic sales growth of 2% to 5%
- Earnings per share (EPS) of $10.15 to $10.65, implying growth of 0% to 1% on the $10.12 reported in 2021
- "Selling price expected to offset raw material/logistics inflation"
- Operating cash flow of $7.3 billion to $7.9 billion, with capital spending of $1.7 billion to $2 billion, implying free cash flow (FCF) of $5.3 billion to $6.2 billion
To put the earnings and FCF figures into context, the midpoint of the ranges implies a year-end price-to-earnings (PE) multiple of 14.5 times earnings and a price-to-FCF multiple of less than 15 times FCF. Those are both attractive multiples for a company with revenue growth and margin expansion opportunities.
Reasons for caution
The numbers and these assumptions make the stock look like an excellent option for investors. Throw in the 4% dividend yield, and 3M remains a good choice for income-seeking investors. After all, its yearly dividend of $5.96 per share is easily covered by current and projected EPS.
That said, there are reasons for caution here.
First, the conflict in Ukraine will inevitably pressure 3M's ability to meet its guidance. The general view in the industrial sector (including 3M's view, as expressed in the meeting in mid-February) going into 2022 was that supply chain pressures and raw material cost increases would ease through the year, leading to profit margins improving at the end of the year.
However, the last thing 3M and the industrial sector needed was an external event that put more pressure on the supply chain and raw material cost and availability. But, unfortunately, that's what's happening now. The conflict caused industry forecaster S&P Global Mobility to downgrade its estimate for global light vehicle production by 2.6 million units a year in 2022 and 2023 and now expects 81.6 million units in 2022 and 88.5 million in 2023.
The automotive original equipment manufacturer (OEM) is a major end market for 3M across its safety & industrial, and transportation & electronics segments. For example, 3M manufactures tapes, adhesives, advanced materials, and electrical products used in the automotive industry. Given the downgrade to global light vehicle production estimates, it's reasonable to expect pressure on 3M's growth assumptions.
In addition, the increase in raw material costs like steel, etc., could pressure full-year margin assumptions.
Falling respirator sales is an issue
The pandemic created a surge in demand for 3M's respirators, so much so that $600 million in sales in 2019 turned into $1.4 billion in 2020 and around $1.5 billion in 2021, compared to overall company full-year sales of $35.4 billion.
However, management expects a decline in respirator sales in 2022, leading to a negative impact of 2% on overall organic sales and $0.45 on EPS. Clearly, respirator sales matter to 3M's earnings, and there could be another decline in sales in 2023.
Still no hard evidence of a turnaround
All told, 3M's earnings forecast is likely to come under pressure due to the conflict in Ukraine. It also means it will be harder to see just how 3M's operational performance has improved after the restructuring actions. That's a concern because the long-term case for the stock depends on management demonstrating it's got the company back on track. So it makes more sense to continue hanging back on 3M rather than jumping in right now.