Own 3M Stock? Here's the 1 Thing Investors Need to Focus On

The industrial conglomerate is under pressure, but it will inevitably attract investor interest due to its 5.6% dividend yield and its stable of well-known and highly regarded brands. So do the positives outweigh the negatives to make 3M (MMM 0.38%) stock a buy? Here's what you need to know.

3M disappoints investors, again

3M has a history of missing its guidance and generating lackluster revenue growth, and profit margins have gone nowhere over the last decade. As such, investors who like management to meet guidance will walk away from the stock.

That said, investing is more about "what happens next?" rather than "what just happened?" So let's take that approach and focus on what 3M needs to do to meet its guidance for 2023.

3M in 2023

Management's guidance for 2023 calls for the following:

• Adjusted organic sales growth in the range of a 3% decline to being flat in 2022.
• Selling prices up low single digits, and volumes down low to mid-single digits.
• Adjusted earnings per share of $8.50 to $9. 

Although management didn't give formal guidance for margin performance, the subject matter came up on the earnings call when one analyst asked, "is that roughly right on that sort of mid-teens operating margin Q1 and 19-ish for the year in your guide?" CFO Monish Patolawala replied, "Yes. Yes, it's actually close there. It's close enough."

Immediately following the earnings presentations, 3M was met with a slew of price target cuts by analysts. Many of which questioned the full-year margin outlook.

Nonetheless, the Wall Street consensus pencils in the full-year "19-ish" operating margin (it's actually 19.1%) and the "mid-teens" operating margin (actually 15.3%). That's fair enough, but the key point here is that 3M's operating margin needs to ramp through 2023 to roughly hit what management expects in 2023. 

Data source: marketscreener.com.

Three question marks around 3M's margins

Unfortunately, there are several questions about 3M's margins. First, as Patolawala told investors on the earnings call that 3M's "volume gives us the best leverage. And what you have seen in Q4 continues into Q1." In other words, 3M tends to expand its profit margin when its sales volumes grow and benefits from scale. However, volumes are expected to decline in the first quarter, and as Patolawala noted on the earnings call, "organic volumes are expected to be down low to mid-single digits for the year."

If organic volumes are declining, and 3M gets its best margin leverage from volume, then it won't be a walk in the park to ramp margin in 2023 aggressively. 

Second, 3M doesn't traditionally rely on pricing to expand margin, and Patolawala's assumption of "selling prices up low single digits" for the full year speaks to that. As such, investors can't rely on pricing action for the margin ramp. 

Third, there's also the problem that 3M is exposed to some deteriorating end markets in 2023. The company has exposure to some interest-rate-sensitive sectors, including home improvement in its consumer business, materials to the semiconductor industry, and also a raft of consumer electronics industries (smartphones, tablets, TVs), as well as substantive exposure to automotive production. If these markets continue to deteriorate (and they are all set to do so in the first quarter),  then 3M's already weak full-year outlook could be under threat. 

Data source: 3M presentations.

Other considerations

Aside from the conditions in 2023, there's also the consideration of how 3M could look coming out of the year. For example, the only segment set to grow sales this year is healthcare -- a business to be spun off in 2023. As such, a lot of 3M's heavy lifting on margin in 2023 will come from a business being separated from the parent company. 

There's also the concern that unfavorable outcomes from litigation could lead to cash calls that could constrain the company's ability to invest, given the $3.4 billion dividend payout it currently makes.

Is 3M stock a buy?

All told, there are valid question marks around 3M's margin in 2023, and the company must work to meet management's and Wall Street's expectations. As such, there are better ways to invest in the industrial sector this year, and the stock is best avoided.