The past few years haven't been good for 3M (MMM 0.46%) shareholders. Then again, the market doesn't care as much about where a stock has come from as it does about where it's going. Moreover, 3M is a leading industrial company generating significant earnings and cash flow, and its dividend currently sports a 5.8% yield. There's a lot to like about the stock, but is it enough to offset the negatives?
Repeatedly disappointing investors
There are two sets of interconnected talking points around 3M right now. The first -- its potential legal liabilities from manufacturing and using per- and polyfluoroalkyl substances (PFAS), and its sale of allegedly faulty combat arms earplugs -- gets most of the mainstream media attention. However, the second -- the company's continual operational underperformance -- is arguably a more worrying factor.
The two are intrinsically linked. Unfavorable outcomes on the legal front could lead to significant calls on 3M's cash -- funds that could otherwise be used to restructure and enhance the business through acquisitions, research and development, etc. In addition, costly legal liabilities could weaken 3M's ability to support its much-admired dividend, impacting the investment thesis for many people who hold the stock for its yield.
Management is actively seeking to reduce its liability risks around PFAS and combat arms earplugs by contesting lawsuits, making plans to exit PFAS manufacturing, and has efforts underway to cease using PFAS in its products by the end of 2025.
Three things management can't do
Nevertheless, legal risk still hangs over the company, and that must be considered by anyone considering the stock. That said, there's only so much management can do about those liabilities now.
In addition, there are two other near-term issues that management also has minimal ability to change in quick order.
3M's end markets are undoubtedly challenged this year -- management forecast is for 2023's organic sales to be in the range of flat year over year to down 3%. In addition, 3M is suffering weakness in key end markets like automotive original equipment and consumer electronics. (Its electronics sales declined 27% year over year in the first quarter.) And its exposure to the construction and home improvement markets isn't helping as rising interest rates have hit the housing market. In addition, a softer-than-expected economic rebound in China is disappointing many industrial companies that have sales into that nation and connected with its manufacturing output.
The final issue 3M can't do much about, at least over the near term, is its pipeline of new products. Research and development has always been vital to the company's strategy -- it has a long history of developing differentiated products and ramping up margins as it scales up production volumes. Management can generate improvement on this front over time, but it's unlikely to happen in the near term.
What management needs to do to make 3M stock attractive
3M management needs to break its unfortunate habit of missing guidance. 3M's history of failing to meet its own expectations is weakening investors' faith in the company.
Data source: 3M presentations.
Indeed, earlier this year, Bert Flossbach, co-founder of one of 3M's largest shareholders, asset management company Flossback von Storch, wrote to management expressing concerns that they kept missing guidance and making positive statements about the business, only to be repeatedly "surprised" by negative events.
Missing guidance is not just about adjusting a number so analysts can tweak their forecasts up and down a bit. The reality is that investors buy into stocks expecting management to hit their forecasts. They also buy into stocks expecting that dividend-paying companies will, at the least, be able to sustain their payouts. For this industrial company, that assumption is built on underwriting earnings expectations.
Furthermore, the company's cost structure and investment decisions are set up in line with these estimates. As such, when 3M disappointed investors again in the first quarter, it wasn't surprising to see it announce another round of costly restructuring. These actions are not only costly to investors, but they are also devastating to employees -- a point worth considering from an ESG perspective when the company reports its progress on the matter.
Image source: Getty Images.
Is 3M stock a buy?
There's little management can do about conditions in its end markets, its legal risk, or its near-term product development outlook. Still, it can execute its restructuring plan successfully and start hitting its own guidance, however weak that guidance is. The good news is there are opportunities to do so, and 3M has a powerful portfolio of products. It's a stock for investors to monitor while waiting for the company to deliver some positive developments.
