The latest earnings from 3M (NYSE: MMM) pleased investors, and the stock rose accordingly. It’s a welcome development for a stock that’s still down 19% in 2022. That said, what does the future hold for the company and its investors? To help answer that question, here’s a look at the big green and red flags waving from the report.
3M’s big green flag
Albert Einstein would be pleased because there’s no better way to describe the mini-collection of green flags than “relative.” 3M’s earnings and guidance weren’t great, but they weren’t as bad as many in the market had expected. In addition, many elements were not as bad as CEO Mike Roman expected when he spoke at an investor conference in early June.
At the Bernstein Strategic Decisions conference in early June, Roman said there would be a negative $300 million impact from the coronavirus lockdowns in China. Also, a combination of sales headwinds and adverse foreign exchange movements would shave $0.30 off second-quarter earnings per share (EPS). Moreover, Roman said supply chain pressures persisted, and raw material inflation was hotter than expected.
Fast-forward to the second-quarter earnings presentation, and CFO Monish Patolawala said the China lockdowns resulted in only $140 million in lost revenue and the EPS headwinds were only $0.24.
The theme continues when looking at 3M’s outlook for the second half. It’s not that some of 3M’s end markets will be stronger than expected in 2022, but rather that they won’t be as bad as they were in the first half. For example, Patolawala talked of “a strong bounceback in China” from the lockdowns, more elective procedures taking place (as COVID-19 restrictions ease globally), and “improving build rate trends in automotive.”
The last one is a case in point: 3M started the year expecting 9% growth in global automotive production for the full year but now expects just 5%. Nevertheless, the increase in the second half over the first is forecast to be 9%. It’s a similar story with smartphone production.
All told, some of 3M’s markets will be better in the second half than the first, even though they are still weaker than expected at the start of the year. Moreover, conditions aren’t quite as bad as expected in early June.
Red flags still waving for 3M
Continuing the utterly superfluous theme of naming 3M’s flags after theoretical physicists, Werner Heisenberg would be interested in the level of uncertainty inherent in 3M’s earnings prospects.
The reality is that 3M did cut its full-year sales and earnings guidance in its earnings presentation. Full-year organic sales growth is now forecast to be 1.5% to 3.5%, compared to a previous estimate for 2% to 5%. Meanwhile, full-year adjusted EPS guidance is now $10.30 to $10.80, compared to $10.75 to $11.25 previously.
There’s also uncertainty around 3M’s raw material and logistics costs headwinds. Management started the year expecting $350 million to $450 million, but it now anticipates $750 million to $850 million.
Moreover, even though second-half production of automobiles and smartphones is expected to be better than the first half (see above), the reality is they are consumer discretionary items. If consumer spending is slowing, then manufacturers will cut production plans.
If that wasn’t enough uncertainty to deal with, there’s the litigation over its combat arms earplugs (3M took a $1.2 billion charge over the issue in the second quarter, but the situation isn’t over yet), not to mention its potential liability over PFAS.
Lastly, the ongoing debate around 3M’s pricing power continues. Patolawala did say that “we did offset inflation” with pricing, but that might not be the case for the full year with the extra assumptions for raw material cost inflation.
All told, it was a mixed report from 3M. Not as bad as many feared, but there probably weren’t enough positives to justify buying the stock outright as the company’s patchy performance continues. Trading at roughly 13.6 times the midpoint of management’s adjusted EPS guidance and 16.2 times its implied free cash flow guidance, 3M continues to look like a good value, and its 4.2% dividend yield is enticing. Still, 3M needs to demonstrate at least a few quarters of maintaining its guidance for investors to feel fully confident in the stock.