3M's (MMM 0.41%) recent disappointing earnings report left analysts scrambling to reduce price targets and the stock dropping 7% over the next three trading days. The stock's dividend yield is now close to 5%, which makes it worth considering, but there's more to the story. Is the sell-off in the stock a buying opportunity, or is the stock worth avoiding altogether?
Not just about PFAS
The first thing to note about 3M is that its woeful stock performance over the past decade isn't just a consequence of its exposure to litigation over its use of per- and poly fluoroalkyl substances (PFAS) (3M will exit PFAS manufacturing by the end of 2025) or even faulty Combat Arms earplugs.
While litigation pressures are undoubtedly an issue, the underperformance at 3M is startling, particularly when compared with the S&P 500 and a multi-industrial peer like Illinois Tool Works.
Data by YCharts
Investors digging below the surface should look at 3M's repeated failure to meet management's expectations. That's been the case whether it was Inge Thulin (2012-2018) or Mike Roman (2018-present) as CEO, and Nick Gangestad (2014-2020) or Monish Patolawala (2020-present) as CFO.
To demonstrate this point, here's a look at management's initial sales growth guidance versus what was achieved. The outperformance in 2021 primarily came from a combination of surging respirator sales and a stronger-than-expected bounce in industrial activity. Otherwise, the company has had a pretty mediocre performance over the past several years.
|
Metric |
2014 |
2015 |
2016 |
2017 |
2018 |
2019 |
2020 |
2021 |
2022 |
2023 |
|---|---|---|---|---|---|---|---|---|---|---|
|
Organic local-currency sales growth, actual |
4.9% |
1.3% |
(0.1%) |
5.2% |
3% |
(1.5%) |
(1.70%) |
8.8% |
1.2% |
N/A |
|
Initial guidance |
3%-6% |
3%-6% |
1%-3% |
1%-3% |
3%-5% |
1%-4% |
0%-2% |
3%-6% |
2%-5% |
(3%) to 0% |
Data source: 3M Company presentations.
Meanwhile, 3M's margin performance has continued to deteriorate.
Data by YCharts
Management takes action
The underperformance would not have been lost on management, and in response, it has taken action to try to improve matters. They include:
- Multibillion-dollar acquisitions and divestments, notably in the ailing healthcare business.
- Reducing operating segments from five to four and a fundamental restructuring of 3M's operating model -- moving toward a business-group-led approach rather than a country-led focus.
- Substantial job cuts aimed at streamlining the company's operations, including 2,900 announced in 2020 and a recently announced 2,500.
- A spinoff of its healthcare business by the end of 2023.
None of it appears to be working. There has been no discernible progress on operating margin or the company's ability to hit its own guidance.
The recent earnings report and 2023 guidance
Fast-forward to the latest fourth-quarter earnings report, and 3M saw organic sales growth of just 0.4%. The company is guiding toward a negative 3% to 0% growth for organic sales in 2023. Roman blamed "rapid declines in consumer-facing markets, such as consumer electronics and retail, a dynamic that accelerated in December, as consumers sharply cut discretionary spending and retailers adjusted inventory levels" and COVID-related shutdowns in China.
However, 3M didn't just disappoint with consumer-related demand in 2022; all of its segments reported disappointing numbers compared to initial guidance.
|
3M Segment |
2022 Organic Sales Growth Guidance (%) |
2022 Actual |
|---|---|---|
|
Safety and industrial |
Flat to low single-digit |
1% |
|
Transportation and electronics |
Low single-digit to high single-digit |
1.2% |
|
Healthcare organic |
Mid-single-digit |
3.2% |
|
Consumer |
Low single-digit to mid-single-digit |
(0.9%) |
Data source: 3M.
Moreover, the weak demand trends are expected to continue in the first half of 2023; Patolawala said, "Organic volumes are expected to be down low to mid-single digits for the year." This is a concern because 3M relies on volume growth to get the leverage that results in margin expansion.
Indeed, management agreed with Wall Street analysts that a mid-teens operating margin was likely for the first quarter of 2023.
Is 3M a buy?
Back in October, management told investors to expect productivity improvements due to moderating raw material and supply chain costs alongside improvements in manufacturing and supply chain actions.
Yet the volume outlook for 2023 implies significant margin pressure, and 3M doesn't appear to have the pricing power in its products to offset volume declines fully. Roman and Patolawala both said they were "not satisfied" with the company's performance, and until they change that view, investors shouldn't feel satisfied, either. The stock should be avoided in the short term.
