Diversified industrial giant 3M (MMM +2.39%) delivered one of the season's most exciting earnings calls. However, it wasn't so much the numbers and the guidance that caught investors' attention. Instead, management outlined a significant restructuring plan that gives hope it might start to release value from 3M's portfolio of businesses.
As such, 3M is becoming an interesting stock again. Here's what you need to know.
3M faces a challenging 2023
First, let's recap what happened in the quarter and the near-term trajectory of the business. It's no secret that this industrial company faces several headwinds. Its consumer segment is under pressure due to weakness in consumer discretionary spending in areas like home improvement, auto care, and home health. Organic sales were down 6.8% year-over-year in the quarter.
Key Data Points
The highly cyclical transportation and electronics segment (down 11.3% in the quarter) suffers as consumer electronics customers (smartphones, tablets, TVs, etc.) reduce inventory due to weak sales.
Meanwhile, the safety and industrial segment (down 6%) faces significant headwinds from declining respirator sales and weak consumer electronics (adhesives). And 3M's healthcare business continues to perform poorly (up only 1.4%).
Despite a slightly better-than-expected first quarter, management maintained its full-year guidance for adjusted organic sales to be in the range of a decline of 3% to flat versus 2022. So no change there.
What's going wrong for 3M
While the company can be forgiven for suffering sales declines in the wake of declining end markets, 3M's long-term performance is less acceptable. As previously discussed, 3M has a history of missing guidance, generating mediocre growth, and producing stagnating margins. Moreover, despite multiple restructuring efforts and mergers and acquisitions activity (notably in healthcare), there are no tangible benefits in its operational performance or share price.
While all of this is going on, there's also the risk of legal liability from PFAS manufacturing and the combat arms earplugs issue , and the possibility that a combination of these issues might even threaten 3M's much-admired dividend.
Image source: Getty Images.
Moreover, there are questions about 3M's business model. Typically, the company invests in research and development (R&D) to produce differentiated products that attract demand and have good pricing power. Then management sets about growing sales volumes, and in doing so, builds scale and geographic reach. This, in turn, ramps up revenue and the profit margin as volume grows.
However, 3M's R&D hasn't generated the products to be able to ramp volume (and grow margin) in recent years, and it doesn't appear to have the pricing power it once did. This is problematic, not only because revenue growth and pricing power aren't great, but because the company is cost-structured for volume growth and expansion that's not occurring.
It also doesn't help that management has appeared overly optimistic in its guidance and expectations in the past. Something had to change.
Management announces a restructuring plan
Here are details of the restructuring announced on the recent earnings call:
- Reduce headcount by 6,000 on top of the 2,500 announced previously.
- Streamline 3M's corporate center, consolidating facilities and management layers.
- Simplify its supply chain structure.
- Adjust its marketing model in about 30 countries around the globe.
- Take pre-tax charges of $700 million to $900 million, with half in 2023 and the rest in 2024.
- Improve annual operating income by $700 million to $900 million as a result of the restructuring.
CFO Monish Patolawala believes these changes will result in "200 basis points to 300 basis points of margin expansion that you should see on an annualized steady-state basis."
Image source: Getty Images.
What the plan means
The restructuring plan looks like the actions of a management team coming to terms with the reality of needing to pare back its corporate structure and headcount to deal with sluggish volume growth. That may sound negative, but it's probably what 3M must do now.
For example, suppose the company's R&D pipeline isn't what it once was. In that case, the business needs to be restructured to reflect that, and management needs to focus on maximizing profitability in its product portfolio. In that way, it can continue to invest in focused R&D to develop products that drive growth.
Is 3M stock a buy?
While there's no guarantee the restructuring will work, the plan is a tacit admission that something had to change at 3M. As such, it should be welcomed by investors. Moreover, if successful, the plan is likely to result in margin expansion, provided there's an easing in supply chain pressures. If 2023 proves to be a trough year in many of 3M's markets, then 2024 is likely to be a year of good earnings growth.
All told, 3M still faces significant headwinds in 2023, and it's a bit early to get excited about 2024, so it's hard to argue that 3M is a buy right now. Still, the investment case for the stock just got a bit stronger, and 3M's valuation makes it a stock worth monitoring.
