3M Co (NYSE:MMM) let investors down with its recent reduction in 2015 guidance and weak 2016 guidance, but beyond the short-term reaction, we may be seeing a fundamental change in a company formerly known for innovation.
Organic growth has collapsed at 3M, forcing management to cut costs and buy back shares to boost earnings per share. Ironically, this leaves fewer workers and less money to invest in future growth that could help the company. It's a downward spiral, and it doesn't look like 2016 will be the year the momentum reverses.
Earnings will be worse than expected
Tuesday's announcement that 2015 organic growth would be 1%, versus a previously expected 1.5% to 2%, was a blow to the company. So were expected earnings per share of $7.55 versus a previous expectation of $7.60 to $7.65 per share.
Management tried to mask the disappointing numbers by pointing out that 2016 earnings per share are expected to grow 7% to 12% to between $8.10 and $8.45 per share. But as I recently pointed out, 3M's EPS growth is really driven by share buybacks funded by debt. That's not a strong position to be in for a company that's supposed to be growing organically.
What's gone wrong at 3M?
The biggest disappointment of Inge Thulin's tenure as CEO has been his inability to boost organic growth. His theory was that greater R&D spending would result in greater growth, but R&D spending hasn't grown much and neither have sales. In 2016, Thulin said 3M will spend $1.8 billion on R&D, which sounds impressive, but that's only up 4% on a compound basis since 2010. Hardly enough to turn around a giant ship like 3M, especially as job cuts are announced on a regular basis. Having worked at 3M for most of the 2000s, I know firsthand that job and budget cuts are hardly conducive to creating an environment that screams growth and innovation.
Part of the problem is that 3M hasn't found that "next big growth driver" like those it has relied on in the past. It used abrasives to fuel growth in the early 1900s, masking tape in the 1920s, Scotch Tape in the 1930s, Post-it Notes in 1980, and brightness-enhancing films in the 1990s. With each booming product, there came extensions, leading to familiar products like Blue Painter's Tape, Post-it Flags, and window film for automobiles. But what's that growth platform today?
Recent R&D hasn't led to any big breakthroughs that could drive future growth, and part of the problem has been 3M's preferred business model.
3M is stuck in the middle
I think the bigger problem is that 3M has positioned most of its recent investments in markets it doesn't control. It has made big investments in electronics, display and graphics, healthcare, and oil and gas during the past decade, but what influence does 3M have in those markets? It has become a middleman, serving customers that are driven by market forces even they have little ability to control.
In many ways, 3M has become like many other industrial suppliers, who are cyclical with the broader economy. When the global economy was growing from 2010 to 2014 and energy spending was growing, the company did well, but now that macro growth has slowed, 3M has little ability to grow its business and has to resort to cost cuts and buybacks to maintain earnings.
Are 3M's best days in the past?
I've been holding 3M stock on the idea that it's a safe company with a solid dividend in an uncertain world. But maybe 3M has positioned itself in a weak spot as a supplier to customers who will always ask for better performance and lower prices.
The more I see 3M struggle to gain traction with new products, the more I worry that this formerly rock-solid company isn't what it once was. Maybe the growth I saw as a bullish sign in 2014 was really just the global economy getting better and 3M was riding that wave. If that's the case, and 3M can't get any traction from new products in the next few years, I'm afraid a long, slow decline for the company may be in store.