If you are someone (like me) who's been critical of 3M (MMM 0.46%) management's inability to meet its own guidance and the long-term degradation in the company's profit margin performance, you must praise the company when it starts getting things right. The latest earnings report was mixed, but there were signs of underlying progress and, on balance, it was a net positive for investors. Still, is it enough to make the stock a buy? Here's the lowdown.
Unpacking 3M's latest earnings report
The results and guidance do indeed need unpacking because they contain a lot of moving parts. On a headline basis, they read a bit like this:
- Second-quarter adjusted sales of $8 billion came in above the high end of the guidance range of $7.7 billion to $7.9 billion.
- Management maintained full-year organic sales growth guidance for a decline of 3% to being flat compared to 2022.
- Second-quarter adjusted earnings per share (EPS) of $2.17 was significantly ahead of guidance of $1.50-$1.75, but management only raised the midpoint of its full-year adjusted EPS guidance by $0.10 -- going from a prior range of $8.50-$9.00 to $8.60-$9.10.
In short, a superficial look at the results reveals a company on track for its full-year sales expectations. But its management is only making a modest improvement in full-year earnings expectations, despite stronger-than-expected second-quarter earnings.
The devil is in the details
It pays to dig deeper into what's going on because the underlying picture is somewhat different. An alternative narrative sees the results as follows:
- 3M's end markets are deteriorating in 2023, and sales are weaker than anticipated.
- The real story here is that 3M is, albeit tentatively, generating an improvement in underlying margin performance that should please investors.
It's a mixture of good and bad.
First, let's focus on the bad. 3M's management risks missing its full-year organic sales growth guidance. I've discussed the company's poor history of meeting its own guidance previously. Fast-forward to the recent earnings call, and CFO Monish Patolawala told investors, "We currently see organic growth tracking to the lower end of our range of flat to minus 3%" due to weakness in key end markets like China, consumer electronics, consumer retail, and industrial markets.
Moreover, the company only beat its second-quarter organic sales growth guidance because foreign currency headwinds weren't as bad as expected. By my calculations, its organic sales growth, excluding foreign exchange movements, was at the high end of guidance, but wouldn't have been beaten by any significant amount.
Image source: Getty Images.
Finally, management's estimates for the decline in disposable respirator sales in 2023 have proved too optimistic. It now expects a $550 million decline in 2022 compared to initial guidance of $450 million to $550 million.
At least from the bad news angle, 3M's end markets are deteriorating, and management appears to have been overly optimistic.
Here's the good
That said, it's easy to be critical in hindsight but much harder to predict where the economy will end up in 2023. Moreover, 3M isn't the only company challenged by the weakness in consumer electronics, retail, and China this year -- the deterioration has been well understood, and management deserves some slack.
Moreover, 3M appears to be making progress on margins. Patolawala told investors to expect an operating income margin in the 19.5%-20% range for the full year compared to prior guidance of 18.5%-19%.
While that may not seem like much, recall that 3M's end markets are weakening, and that implies softening volume growth -- an added difficulty for a company like 3M that needs volume growth to expand profit margins. While in part it comes down to better-than-expected raw material and energy cost inflation, management's restructuring actions appear to be taking shape. They are helping improve its supply chain operations and streamline its corporate structure.
Image source: Getty Images.
Is 3M stock a buy?
If you are worried about the near-term environment, the stock is not a buy, because 3M's end markets are deteriorating. That said, if 3M can hit its margin expectations for 2023, investors can feel that management is progressing on its longer-term objectives. In addition, 3M beating estimates and raising full-year earnings guidance is not bad, and precisely what investors want to see from the company.
The results may not be the game-changer some were hoping for to make the stock a buy. But they are a step in the right direction, and 3M is a stock worth monitoring.
