3M | Fundamental Analysis

The continued poor performance of 3M stock indicates that investors are beginning to lose patience with the company. At the last investor presentation, management resigned from the full-year outlook it gave at the end of October. Thus, the company's stock is even falling out of favor with value-oriented investors and increasingly evolving an option only for dividend investors.

Let's take a closer look at what's going on and whether 3M has investment potential.

In early December, MMM CEO Mike Roman and CFO Monish Patolawala spoke at the Credit Suisse Industrial Companies Conference. They immediately told investors that organic sales growth in Q4 would be in the "lower half" of the expected growth range of zero to negative 2%.

When a company lowers its sales estimates, it's never good news, but the update from 3M particularly disappointed investors. There are three reasons for this:

First, the lower sales forecast came after management raised its full-year organic sales growth forecast in late October during its Q3 earnings presentation. In the third quarter, full-year organic sales growth was between 6% and 9%, but management noticed fit to increase the lower end of the range to 8%-9%, even as the full-year profit forecast was lowered to $9.70-$9.90 from $9.70 to $10.10.

Considering that the assumed outlook for the fourth quarter has been lowered, investors are justifiably lowering earnings growth expectations. It also begs the question of why Patolawala decreased anticipations weeks after increasing them.

Second, it's no secret that investors are watching 3M's margins closely for clues as to whether its restructuring measures are bringing operational improvements. Of course, it's much harder to judge this during a pandemic, but Patolawala has previously noted the significance of volume gain to 3M's margins. Given that sales growth will be weaker than expected, 3M's margins are likely to come under even more pressure in the fourth quarter.

Third, management noted that it continues to experience supply shortages and high raw material costs. In other words, cost pressures will intensify in the fourth quarter. Consequently, 3M is seeking to raise prices so that the difference between price and raw material costs becomes margin neutral. At the conference, Patolawala was asked about pricing, to which he replied that investors should "wait and see" what prices 3M gets at the end of the quarter.

The disappointing comments about pricing and the fact that 3M has not been able to offset rising costs with pricing actions call into question the company's business model and/or ability to execute it. For the record, 3M prides itself on investing heavily in research and development to produce differentiated products that have pricing power. Unfortunately, that pricing power is not apparent right now.

Moreover, in recent years, company management has taken significant restructuring measures to improve performance. Indeed, during its third-quarter earnings call, Patolawala told investors that restructuring costs in 2021 would be between $300 million and $325 million, up from a previous forecast of $250 million to $300 million.

Moreover, 3M management has restructured the business (business groups are now managed globally rather than by country) and the healthcare segment has been restructured through multibillion-dollar acquisitions and sales.

So far, none of these restructuring actions has resulted in a noticeable improvement in growth or margins.

Still, it's hard to be too critical of a company's management during a difficult trading period. In addition, Patolawala talked about the likelihood of improvements in volume growth, pricing, lower raw material costs, and the benefits of restructuring in the future. All of these factors point to higher margins in the future.

In addition, 3M stock currently has a dividend yield of 3.5% and is well covered by free cash flow. Thus, the stock remains a good option for income-seeking investors.

Finally, it relies on your investment profile. If you're looking for a relatively safe income source, 3M stock is a useful buy. However, poor operating performance and disappointing guidance will worry investors who prefer to see evidence of progress before buying. For those investors, it makes sense to wait and see what 3M reports in its subsequent earnings releases and what margin growth is projected for 2022.