Usually, when a stock is up 23% after an earnings release, it is due to spectacular outperformance and a significant hike in guidance. Some of that applies to 3M(NYSE: MMM). However, the real takeaway from the report is that long-suffering 3M shareholders heard a lot of what they wanted to hear from new CEO Willliam Brown. Here's the lowdown and why Brown's commentary made such a refreshing change.
3M's earnings
Before discussing the qualitative issues, let's examine the numbers that helped propel the stock. In a nutshell, a combination of some improvements in key end markets like consumer electronics, semiconductors, and automotive aftermarket, and improving margin performance due to ongoing restructuring actions, helped 3M to better-than-expected second-quarter earnings.
As such, management hiked the midpoint of its margin and earnings expectations for the full year. While the increase in the midpoint of the full-year earnings per share (EPS) guidance from $7.05 to $7.15 is welcome, it's not enough to justify the increase in the share price post-results.
3M Full-Year Guidance | Prior Guidance | Current Guidance |
|---|---|---|
Adjusted organic sales growth | Flat to 2% | Flat to 2% |
Adjusted operating margin | Up 200 bps to 275 bps* | Up 225 bps to 275 bps* |
Adjusted EPS from continuing operations | $6.80-$7.30 | $7-$7.30 |
Data source: 3M presentations. Bps is basis points, where 100bps equals 1%.
Enter Willam Brown
Former L3 Harris Technologies CEO William Brown took over as 3M CEO on May 1, and his presentation on the earnings call made it clear he's taking a comprehensive approach to improving the company's lackluster historical performance. With former CEO Mike Roman moving to the role of executive chairman, there were some concerns that Brown might not take a full-throated approach to restructuring the industrial giant.
Fortunately, Brown's forthright presentation dispelled those fears. Perhaps the most refreshing part of Brown's commentary was his admission that 3M's "organic growth has been below market indices and peers over several years and up only about 1% year-to-date."
This is only what the market has seen over the years, but admitting it is the first step in rectifying it.
What went wrong with 3M
Brown identified several reasons why 3M's growth hasn't been what it could have been in recent years. For example, he argued that an overemphasis on the healthcare business now spun off as Solventum meant that research and development (R&D) investment excluding Solventum "has been flat nominally over the past five years and down on a real basis."
As such, the company's lack of R&D investment in its core business resulted in fewer new product introductions (NPI), and "revenue from new product introductions has steadily declined over the past decade."
At the same time, as previously discussed, management's substantial efforts to restructure Solventum through mergers, acquisitions, and investments did little to change the business' growth trajectory.
With Solventum gone, Brown wants to adjust the R&D budget over time to drive NPIs, and the dividend cut initiated this year will enable him to do that.
Image source: Getty Images.
Operational improvements and portfolio restructuring coming
That said, it will take time for R&D (traditionally a strength of 3M and what drives volume growth) investment to bear fruit, and Brown aims to squeeze every ounce of productivity from its existing operations. This includes reducing supply chain complexity and leveraging its buying power to improve quality and lower supplier costs. He's also looking to rationalize 3M's substantive factory and distribution center footprint.
In addition, Brown believes 3M can significantly reduce the amount of inventory it has to service sales, freeing up $1 billion in working capital. He's also taking a "fresh dispassionate look at our portfolio to determine if any assets have greater value owned by others."
As to what kind of growth rate Brown expects 3M should have, he noted, "We should be growing at least at the level of the economy, if not perhaps slightly better," and promised more details toward the end of the year.
What it means to 3M investors
3M has always been a company aiming to drive pricing power in its products and volume growth by offering innovative NPIs generated through its R&D. Brown intends to reinvigorate that model with focused R&D. In the meantime, he's looking to create significant operational improvements while actively looking at pruning less profitable businesses.
While much of this is Business 101, Brown has a track record at L3 Harris to back him up, and 3M's valuation (even after the recent rise, it trades on 17.8 times the midpoint of management's estimate for full-year earnings) is still attractive enough to buy the stock as a value play on the basis that Brown can improve 3M's performance at least in line with that of its peers.
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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends 3M and Solventum. The Motley Fool has a disclosure policy.
