3M's (MMM 0.33%) premarket announcement on Dec. 15 didn't seem terrible, but the market's reaction certainly was. The company said it was cutting guidance on 2015 organic revenue growth to 1% from a range of 1.5% to 2%, and the 2015 EPS forecast was reduced to $7.55. 3M said it expects 2016 organic revenue growth between 1% and 3% and for EPS to increase between 7.3% and 11.9%.
Shares dropped 6% in response, on a day when the S&P 500 rose by 1%. The stock recovered 1.2% the next day as the S&P 500 celebrated the return of something resembling monetary policy with a 1.5% increase.
3M has struggled to achieve any organic revenue growth in 2015, and it will continue to do so at least until the fourth quarter of 2016, as the upper end of its new revenue forecast seems unattainable. Heavy reliance on foreign markets, a product mix with a tilt toward construction, and products for which customers can readily find substitutes don't mesh well with an environment of slow or declining economic growth and dollar strength, and essentially zero inflation. Neither prices nor volumes are likely to come to 3M's aid.
Margin won't, either. 3M is already remarkably lean for such a large, disparate, and geographically dispersed corporation, as an operating margin of 23.7% in the first nine months of 2015 proves. While 3M continually seeks cost savings, restructuring charges of $100 million in 2015 will result in only minor savings in 2016. The company expects what it calls its "Business Transformation Strategy" to generate cost reductions of $500 million to $700 million over the next five years and working-capital savings of $500 million over the same period. But relative to last year's pre-tax costs of $24.8 billion and working capital of $5.8 billion, these savings, while certainly welcome, are hardly transformative.
There is probably little the company can do to accelerate benefits from this strategy, much of which involves a major upgrade to its enterprise resource planning systems. Companies that aren't managed as well use downturns to force through efficiencies, but 3M's discipline of continuous improvement leaves it little in the way of easy, short-term cost reductions to implement, now that times are less forgiving.
The reward for corporate virtue seems to be unrealistic expectations. When these expectations are finally punctured, even the stocks of undeniably excellent companies such as 3M suffer.
Acquisitions and divestitures may bolster growth and/or margins a little, but not dramatically. Major purchases aren't 3M's style, and the acquisitions it makes, while almost always accretive to earnings in the first year, are generally lost in the rounding error of pre-tax income, which exceeded $7 billion in 2014. It's a similar story regarding divestments: After several years of concerted portfolio pruning, there are few if any big drags on growth or margin left for it to dispose of.
To attain the 7.3% to 11.9% EPS growth 3M forecasts for 2016, the dollar must retreat very significantly from its current levels; GDP growth in the U.S. must increase very sharply, or GDP growth worldwide must increase fairly solidly; inflation worldwide must increase to the extent that 3M can force through significant price increases without losing market share; or 3M must repurchase 7% or more of its shares outstanding.
At current prices, a repurchase of that size would cost somewhere north of $6.4 billion. In the slides that accompanied 3M's presentation, $6 billion gross is the upper range it gives for its share repurchase plans in 2016. So 3M, like just about everyone else, clearly regards the other three alternatives as unlikely. If it's able to report any EPS growth in 2016, most -- and probably all -- of it will result from repurchasing shares, much of it with borrowed money.
Investors seem to be less and less impressed with this sort of earnings manipulation. 3M's investors in particular seem to be nostalgic for the days when earnings per share were earned rather than bought. But their patience won't last forever: Nine-month net income was down 0.5% before share repurchases transformed it into a 3.5% increase.
3M remains one of America's most impressive companies, but current conditions simply don't provide it with the opportunity it needs to demonstrate its time-tested strengths. These conditions are unlikely to change until the end of 2016 at the earliest. It's currently yielding 2.7%, which is some compensation for a clouded outlook, but hardly a strong inducement to buy.
