Industrial giant 3M(NYSE: MMM) just underwent a major change, spinning off its healthcare business and cutting its dividend by a whopping 50%. The stock had been largely unloved on Wall Street for years leading up to these events. But the shares rocketed 25% higher after second-quarter earnings.
Is 3M stock a buy, sell, or hold at this point?
What happened to 3M?
Legal and regulatory issues have been weighing down 3M's stock for years. The two most notable headwinds are product liability issues around earplugs 3M sold to the military and legal and regulatory issues around forever chemicals the company produced. The concern among investors was legitimate; these are billion-dollar issues to deal with.
The company has, however, been tackling the problems head-on. For starters, it has been working on legal and regulatory resolutions. There are big costs associated with this effort, but it is important for the company to close the door on this episode of its existence. Notably, in the second quarter of 2023, the company took a one-time charge worth $14.43 per share, pushing earnings deeply into negative territory, to account for the resolution effort.
From a long-term perspective, the problem was finding a source of cash to pay for the costs without overburdening 3M's balance sheet with debt. The solution was to spin off the company's healthcare business, an effort that was completed with the creation of Solventum(NYSE: SOLV). That transaction freed up cash that basically went to cover legal expenses. The downside here is that the healthcare division was expected to be an important growth driver for 3M's business.
Buy 3M stock?
The 3M story is definitely getting better. It is working through the legal and regulatory issues and has found a way to pay for the associated costs. And notably, management appears to think the future won't be as bad as it feared at the start of the year. To that end, it changed its full-year 2024 earnings guidance range from $6.80 to $7.30 per share to $7.00 to $7.30 when it reported second-quarter earnings. That notably increases the midpoint of guidance.
It is clear that 3M has made important progress in turning its business around. Despite that progress and the swift stock price advance, the shares remain well off their highs and far behind the average industrial stock, using Industrial Select Sector SPDR ETF(NYSEMKT: XLI) as an industry proxy. So, if you like turnarounds, it appears there's probably more room for 3M to recover. Just go in knowing that any gains from here probably won't be as quick or dramatic as the post-earnings bump.
Hold 3M stock?
Whether you have owned 3M for a short period of time or a long one, the big story is still the directional shift in the outlook. Why would you sell now if the business is starting to show some progress? The answer is you probably shouldn't. There is one caveat. If you bought near the lows with the idea of trying to get in before a rally, well, a big part of the upside may have been accounted for with that 25% post-earnings price jump. It wouldn't be unreasonable to consider taking some money off the table, counting the trade as a fairly quick win, and moving on to another opportunity.
Sell 3M stock?
Even after all of this, however, there are still reasons you might not want to own 3M. For example, the earnings guidance raise was basically a sign that management thinks things will be less bad. The midpoint increased because the low end of the range was raised, not because the high end of guidance improved. Then, there's the fact that the second quarter still saw $0.44 per share of legal expenses, down dramatically from the prior year, but it shows that the legal and regulatory issues are not fully behind 3M just yet.
From a longer-term perspective, meanwhile, investors need to consider the impact of the healthcare spin-off. 3M basically had to sell the crown jewels to ensure its survival. What's left of the company isn't bad; it just doesn't have the same long-term growth potential. So, 3M isn't the same company it was just a few years ago.
Slow and steady growth from an iconic industrial stock isn't a bad thing, but the 2.1% dividend yield here probably won't be all that attractive to income investors. And since the earnings growth opportunity here isn't as notable as it was, the business probably won't appeal to growth investors, either. This means 3M still looks like its primary appeal is the turnaround opportunity, a type of investing that only the most aggressive investors should take on.
3M is not a great fit for most investors
At the end of the day, 3M isn't a bad company. But it is still a company dealing with material change that has been driven by big legal and regulatory headwinds. Most investors will probably want to err on the side of caution and look elsewhere, even though the company is starting to see the light at the end of the tunnel. For better or worse, the big price spike after second-quarter earnings has probably already priced in a lot of good news.
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Reuben Gregg Brewer has positions in 3M and Solventum. The Motley Fool recommends 3M and Solventum. The Motley Fool has a disclosure policy.
