I think there's good reason to believe industrial giant 3M's (MMM +1.25%) full-year sales outlook could be under significant pressure, and management could, yet again, miss its full-year expectations based on its initial guidance. There is an investment case for buying the stock, but it makes sense to weigh the risks and rewards before investing money.
Why 3M could miss its sales guidance
There are three interconnected reasons why investors need to be cautious about the matter:
- Having started the year forecasting full-year organic sales to decline 3% to being flat on 2022, management told investors (in late July) that it now expects sales at the "lower end" of the range for 2023. Momentum is against 3M.
- China is a key end market for 3M, and the recovery in that country has turned out weaker than many expected going into 2023.
- 3M's sales are threatened by anecdotal signs of weakness in the industrial sector, notably in key industry verticals it sells into, and the likelihood of industrial companies reducing inventory.
Key Data Points
Declining sales momentum and China
The cut in full-year sales expectations (although not a cut in guidance because management said it would likely come in at the lower end of the range) is disappointing, particularly as 3M's management doesn't have a good track record of meeting its sales guidance.
That said, there's little management can do about a deteriorating end-market outlook in 2023, starting with China.
Many industrial companies, including 3M, hoped China's industrial output would bounce back as pandemic-related restrictions were lifted in 2023. The following chart, taken from the official National Bureau of Statistics in China, shows how the bounce occurred in the first quarter but has gradually petered out as the year progressed (a reading above 50 indicates growth). Not only are Chinese purchasing managers reporting a slowdown in conditions (as measured by the purchasing manager index), but also new orders.
That's an issue for 3M because, as CFO Monish Patolawala said on the first-quarter earnings call in April, "our full-year guidance, as I have talked about, assumes overall recovery in all economies in the second half, including China." For reference, the Asia Pacific region contributed nearly 29% of 3M's sales in 2022, significantly larger than Europe, Middle East, and Africa contribution of 17.3%.
Data source: National Bureau of Statistics in China. Chart by author.
Industrial sector and 3M sector-specific weakness
Discussing the reason for the downgrade to expectations on the second-quarter earnings call, Patolawala cited a lack of improvement in key end markets like "electronics, consumer retail, industrial, and China."
3M has broad-based exposure to the industrial sector through its sales of abrasives, adhesives/tapes, advanced materials, and electronics materials, with notable exposure to electronics, semiconductors, smartphones, and automotive end markets. In addition, it has exposure to consumer retail through home improvement and home care product sales.
What companies are saying
I want to highlight what two companies recently said about consumer electronics and semiconductors. Cognex (CGNX 1.82%) manufactures and sells machine vision systems manufacturers use, and Keysight Technologies (KEYS 1.07%) makes design and test solutions. Both are interesting because they tend to have short-cycle orders that come through when customers ramp up activity.
For example, Apple (a Cognex customer) might order more machine vision equipment to help it ramp up production of phones in the third and fourth quarters ahead of Thanksgiving and Christmas.
Image source: Getty Images.
Cognex's CEO Rob Willett recently told investors of slower manufacturing activity "including Germany and the United States," noting that "customers remain cautious with their capital investments, particularly in consumer electronics and semi where we have seen the steepest decline in demand."
It's a similar story at Keysight, where CEO Satish Dhanasekaran recently said, "Demand was incrementally weaker in Asia this quarter as customers deferred manufacturing-related spending in semiconductor, general electronics, and automotive markets in many cases well into next year."
Meanwhile, rising interest rates continue to pressure U.S. consumer sales in rate-sensitive areas like housing.
A stock to buy?
There's no way to sugarcoat this. The weakness in short-cycle orders at companies like Cognex and Keysight points to near-term issues in some of 3M's key end markets, notably in China. As such, don't be surprised if 3M misses its full-year sales guidance.
Long-term investors shouldn't worry too much, as a few quarters of slowing sales won't matter to the big picture because management is actively restructuring the business and pointing to underlying improvements in its margin profile. Still, end-market conditions will likely worsen before they get better for 3M, which should be factored into investor perceptions of the stock.
