3M's (MMM -0.27%) 5.5% dividend yield is compelling, but it's not enough to offset the company's problems.
A company's ability to meet guidance and to generate revenue growth and margin expansion are critical considerations when investing in a stock. Unfortunately, based on recent history, 3M is, arguably, failing on all three counts.
Unhappy shareholders
One of 3M's significant shareholders, Flossbach von Storch, isn't satisfied with its performance. The asset manager's co-founder Bert Flossbach has already written to 3M's management and expressed concern about how it's being run, and about management's positive statements regarding the company.
Flossbach has a point. The chart below shows 3M's recent history of meeting the guidance range for organic local currency growth that management gave at the beginning of each year. Forget about beating the high end of the range: 3M only managed to beat the low end of the guidance range in four of the last nine years, and in one of those (2018) it just scraped through. Moreover, 3M only beat the high end of guidance in 2017 and 2021, when industrial production growth bounced strongly from trough years.
It gets worse. 3M held an investor day in 2016 and targeted annual local-currency organic sales growth of 2% to 5% in 2016-2020; in 2019 it held another investor day and targeted 3% to 5% in 2019-2023. If 3M manages to hit the midpoint of its 2023 guidance, then average annual growth over the 2016-2023 period will be just 1.7%.
Whether you look at it year by year or or over the medium term, 3M's record of meeting guidance is not good.
Data source: 3M presentations. Chart by author.
Disappointing margin performance
3M traditionally commands relatively high profit margins, partly because it focuses on research and development to create high-quality and differentiated products. The company invented the new-product Vitality Index -- a measure, now widely used in industry, of the share of sales coming from products released in the last four years.
Indeed, 3M continues to command excellent gross margins and margins based on earnings before interest, taxation, depreciation, and amortization (EBITDA). Gross margin is helpful as it indicates a company's pricing power in a marketplace -- it only strips out the cost of goods. EBITDA margin also strips out operating expenses.
However, the problem is that neither its gross margin nor its EBITDA margin have gone anywhere over the last decade. A combination of lackluster growth and margin decline doesn't make good reading for shareholders.
Data source: Morningstar.com. Chart by author? --EKS
What's going wrong at 3M
This disappointing operational performance is part of why the stock is down 54% over the last five years compared to the S&P 500's 46% gain and the 43% increase at one of its multi-industrial conglomerate peers, Illinois Tool Works.
Meanwhile, CEO Mike Roman earned nearly $6 million in incentive payments (on top of $3.9 million in salary) in 2019-2021, and CFO Monish Patolawala (appointed in July 2020) earned $1.9 million in incentive payments (on top of $1.4 million in salary) in 2020-2021. During these years, management made significant restructuring actions -- none of which seem to have improved performance.
3M is having problems maintaining its margins. One obvious answer is to try and raise pricing, but that's not how 3M operates. Instead, as Patolawala said to Barclays analyst Julian Mitchell on the last earnings call, "as I've always said ... the volume gives us the best leverage." In other words, 3M tries to generate margin expansion through growing sales volume (and taking advantage of the benefits of scale) rather than pushing through price increases.
One possibility is that 3M doesn't have the pricing power to push through price increases without suffering volume decreases. Alternatively, it might not have enough quality in its products to generate the volume necessary to expand its margin. In either case, 3M is not demonstrating the ability to grow margins.
Image source: Getty Images.
Why guidance matters
Not hitting guidance isn't just an issue of disappointing investors who bought the stock by failing to pencil in the numbers the company gave earlier; it also raises questions about executive planning. For example, if margins are supposed to expand primarily due to volume growth, and management is getting assumptions about sales volumes wrong, then it's not hard to see where problems could occur. In addition, a business structured for one volume has a different cost profile than one structured for another.
Indeed, after yet another year of missing guidance and now expecting lower volume in the first quarter, management expects a first-quarter operating profit margin in the mid-teens, compared to 21.4% and 24.1% in the previous two years' first quarters.
Until management can demonstrate an ability to hit guidance, grow revenue meaningfully, and increase margin, it's hard to make a case for buying the stock -- with or without a 5.5% dividend yield.
