“We continue to focus on delivering for our customers and shareholders in a challenging economic environment with slowing growth, inflation, and supply chain disruptions.”
When this is the first thing the Chairman and CEO of 3M says on an earnings call, you get the impression that there is plenty of bad news to come.
This is confirmed when Mike Roman’s next sentence is, “We posted organic growth of 0.4% versus our expectation of 1% to 3%, along with adjusted margins of 19% and adjusted earnings of $2.28 per share.”
Here’s what we can take away from the recent 3M 2022 Q4 Earnings Call.
Consumer Demand for 3M Goods Is Falling Faster Than Expected
3M highlighted ‘negative trends’ in its consumer retail and electronics businesses in November. The slowdown has turned out faster than anticipated. Sales in its consumer business fell to $1.2 billion versus $1.5 billion in the respective quarter in 2021. Organic sales also reduced by 5.7%.
Sales were particularly weak in the United States, where its consumer business was down in the high single digits. Consumers are reining in their spending, and retailers are cutting inventories.
Margins and Consumer Income Took a Hit
Given headwinds of consumer weakness, higher prices for raw materials, stress on productivity, and higher costs of outsourced manufacturing, income in the consumer business took a big hit – at $224 million, down 24% compared to last year.
Unsurprisingly, margins slipped quite a way, too – down 3.3 percentage points to 17.9%.
Actions Taken By 3M to Address The Weakness
This outcome could have been worse. 3M’s management took several actions to “navigate the fluid and slowing macroeconomic environment”. These included:
- Increasing prices
- Reducing manufacturing output
- Capping spending
- Restructuring to streamline the business
Monish Patolawala (Chief Financial and Transformation Officer), said that these actions delivered an underlying benefit to operating margins of 110 basis points and $0.19 to earnings per share.
China, Russia, and Currency – Soft, But a Mixed Bag
Compounding its woes, and like most other businesses are reporting, 3M took a hit because of the challenges to its business in China and Russia, and because of adverse currency movements:
- In China, Covid-related impacts reduced organic sales by 17% in December
- The exit from Russia removed another chunk of revenue – equivalent to $0.15 per share in earnings
- Currency translation resulted in a negative of $400 million, or 5%. However, this was better than the 7% negative impact it had expected
Away from the Consumer Business, 3M Performed a Little Better
Moving away from 3M’s consumer business, the company performed better, despite experiencing similar headwinds:
- Safety and industrial grew its organic sales by 7.5% after stripping out the decline in demand for disposable respirators (though personal safety business declined by mid-single digits). This growth was led by low single-digit growth in electrical markets, automotive aftermarket, and abrasives. Consequently, operating income in this sector was up 9% in the corresponding quarter last year, at $611 million – with margins of 22.4% up 2.7 percentage points
- Transportation and electronics reported sales of $2.1 billion – organic growth of 1.4%, despite a 10% fall in its electronics sales caused by weaker sales in the end market (especially smartphones, tablets, and TVs). Overall, the sector delivered $366 million in adjusted operating income, with margins up 60 basis points at 17.8%.
- In healthcare, sales posted organic growth of 1.9% from last year, though sales in medical solutions fell in the low single digits. PG experienced higher organic sales in separation and purification and health information systems. However, manufacturing costs, and higher raw materials and logistics prices, combined to pressure margins (down 2.9 percentage points to 20.6%) and reduce quarterly operating income by 18% year-on-year to $421 million
Share Repurchases Made Up for Reduced Earnings from Divestitures
Monish Patolawala explained that divestitures reduced earnings per share by $0.04 compared to a year earlier. But, compensating for this, other financial items increased EPS by $0.09.
As Monish said:
“During the quarter, we returned $1.4 billion to shareholders through the combination of cash dividends of $820 million and share repurchases of $540 million.
“For the year, we returned $4.8 billion to shareholders, including $3.4 billion in dividends and $1.5 billion in share repurchases.
“In addition, we reduced our outstanding share count by 16 million shares via an exchange offer associated with the food safety divestiture.”
EPS Declined vs A Year Ago
Organic sales growth fell short of 3M’s expectations. Consumer demand for 3M products has weakened considerably. The company has faced all sorts of pressures, and its margins have suffered. While its non-consumer businesses have fared better than its consumer-focused operations, results here have also been mixed.
The outcome? Adjusted earnings per share of $2.28 versus $2.45 a year ago.
Little Respite Predicted
3M are in a battle. It sees little respite from the tough economic and business conditions in the first half of 2023. For the full year, it is forecasting organic growth of between zero and minus 3%, and EPS of between $8.50 and $9.00 – down from $9.88 on an adjusted basis for full-year 2022. This includes a negative impact of $0.55 to $0.80 on EPS due to the decline in disposable respirator demand, exit of Russia, foreign currency translation, and divestitures.
The company has announced further measures to reduce its costs. These include reducing headcount by 2,500 – a move that will incur a restructuring charge of up to $100 million in the first quarter of 2023.
In summing up, Mike Roman said:
“We are not satisfied with our progress or performance. We are taking additional actions, building on the actions taken in the second half of 2022 to reduce cost structure and inventory. We have implemented strict control of hiring and discretionary spending.”
Monish Patolawala said:
“While there are a number of headwinds to earnings in 2023, ultimately, our full year performance will be driven by organic sales volumes, sustained progress in global supply chains and raw material availability, and our ability to drive improvements and reduce costs in our manufacturing and supply chain operations…
“Before we go to Q&A, I want to walk through how we are seeing the first quarter. First, three weeks into January, we are seeing continued slowing in organic sales volume as we start the year. This slow start is driven by the same weakening end-market trends that impacted the finish to 2022. We expect soft consumer discretionary spending, along with retailer destocking, to continue into the first quarter…
“We estimate Q1 total adjusted sales in the range of $7.2 billion to $7.6 billion, versus $8.5 billion adjusted for the exit of PFAS manufacturing, or down 10% to 15% year on year…
“From an EPS perspective, we estimate that first quarter adjusted earnings per share will be in the range of $1.25 to $1.65…
“Ultimately, organic volume trends would be the biggest factor in determining how the quarter will turn out…
“2023 is an important year as we work on progressing our strategies, including preparing for the spinoff healthcare, improving our manufacturing and supply chain operations, and taking actions to further streamline the organization. We are focused on creating the shortest path to the customer and providing innovative solutions to their most challenging problems. We will remain nimble and take appropriate actions as we respond to changing market dynamics. And we will continue to invest in growth, productivity, and sustainability to ensure the long-term success of our enterprise.
“To wrap up, I continue to be bullish on our long-term trends. The large and attractive end markets we serve provide exciting opportunities for the future of 3M. We are not satisfied with our performance and the expected start to this year. We are working to aggressively address our operating performance in this challenging environment.”
The Bottom Line
It’s clear that 3M is having a tough time in the current economic environment. It is fighting hard to control costs, but, like Patolawala says, it is the consumer that will decide its fate.
By its own admission, 2023 has not started well for 3M. However, it has been here before. It has weathered economic storms successfully in the past. If 3M can remain nimble, and if the economy does not soften as much as it expects, then we could see a bounce in consumer demand that will deliver 2023 EPS at the top of the range. They are big ifs. The forward dividend yield of 4.85% looks highly attractive to the long-term investor, but, until there is more clarity in the market, the dividend yield may become even more attractive in the coming weeks