With earnings season underway, I thought it's time to address the question of whether it's a good idea to buy 3M (MMM 0.16%) stock right now. The stock's 5.6% dividend yield and its potential to improve profit margins via its restructuring initiative attract investors, but is it enough to offset concerns over its future capital-allocation policy and end markets in 2024? Here's what you need to know before buying the stock.
The bulls' case for 3M stock
The best case rests on the idea that 3M is now a deep-value stock with turnaround prospects. In other words, with the stock trading on just 13 times the estimated 2023 earnings and yielding 5.6%, investors are entitled to feel that simply executing its restructuring initiatives will be enough to take the stock materially higher.
The initiatives should result in higher profit margins and, as a large diversified 3M, should be able to generate revenue growth in the low-single digits (in line with economic growth) in 2024. The result will be the kind of high-single-digit growth in earnings Wall Street expects from 3M in 2024. That's fine for a company yielding significantly more than the 10-year Treasury rate of slightly less than 4%.
Key Data Points
The bears' case
There are four factors to consider for the glass half-empty view.
First, 3M is set to spin off its healthcare business in 2024. While the 19.9% stake management will retain will give it financial flexibility (the stake could be sold to raise cash), the spin-off removes 3M's most stable source of earnings. It will leave the company holding three cyclical segments. This is a point highlighted by the fact that the healthcare segment is the only one to report year-over-year growth in the first three quarters of 2023.
Second, the multiyear- and multibillion-dollar settlements (for combat arms earplugs and 3M's PFAS) and the loss of cash flow from the healthcare business mean 3M's management and board may decide to change its capital-allocation policy. More specifically, they may cut the dividend.
Image source: Getty Images.
Third, management has a less-than-stellar record of meeting its guidance, let alone beating it. This is not only an issue for investors being able to pencil in valuations, but it also suggests the company is not structuring its business correctly, meaning its cost structure is based on "x" amount of sales when it's only delivering "y." This is possibly why 3M's margin performance has deteriorated over the years.
The fourth reason comes down to its deteriorating end markets. It's a subject that deserves a closer look.
3M's end markets in 2024
As noted above, the three segments that will remain part of 3M, namely safety and industrial, transportation and electronics, and consumer, have reported declining year-over-year organic growth in the first three quarters of 2023. Moreover, management expects them all to fall for the full year 2023.
In addition, there's evidence that they will continue to come under pressure at the start of 2024. For example, metalworking and maintenance, repair, and operations (MRO) distributor MSC Industrial has already reported its first quarter of 2024 (a quarter that ends in early December) earnings, and the news isn't good. The company's sales deteriorated more than expected in the second half of October, and its average daily sales growth was also negative in November and December.
Image source: Getty Images.
That's not a good sign for the industrial sector and definitely not for a company like 3M that sells abrasives, packaging systems, industrial adhesives and tapes, materials, and many other solutions to the industrial sector. In addition, Delta Air Lines reported a 24.2% drop in its cargo revenue in Q4; another sign of a slowing industrial economy. Delta's cargo-revenue decline comes on the heels of FedEx's CEO Raj Subramaniam telling investors, "We have seen now the market demand weakened primarily because of slowdown of industrial production across the world," on the company's Q2 2024 earnings call in mid-December.
Is 3M a stock to buy?
It's hard to see how 3M's management will sign an extremely confident note on its earnings report on Jan. 23, at least in terms of its end markets. Some of its key industrial verticals, including consumer electronics and automotives, are interest-rate sensitive, and conditions remain challenging.
Image source: Getty Images.
Given 3M's increased exposure to the industrial economy post-spin-off, investors shouldn't expect too much from management's 2024 guidance, and that could weigh heavily on the stock and possibly impact its capital-allocation strategy too.
On a brighter note, lower interest rates later in the year will definitely help 3M, and the company is in restructuring mode, so investors tempted to buy in might want to wait until the company issues its full-year outlook.
