NASDAQ:MMM 3M Stock Turbulent First Half of 2023

The fortunes of industrial behemoth 3M (MMM 4.47%) have been decidedly mixed in the first half of 2023, with shares plunging by a notable 16.5%, according to S&P Global Market Intelligence data. In stark contrast, the benchmark S&P 500 index enjoyed a 15.9% surge over the same period. The troubling trend reflects a raft of challenges that have battered 3M on multiple fronts.

These challenges can be broadly categorized into operational, end-market, and administrative, three key elements that investors usually scrutinize when assessing a company's performance. Regrettably, 3M failed to deliver promising results in any of these areas.

Operationally, the company stumbled right out of the gate, falling short of its revenue growth forecast in the final quarter of 2022. On a subsequent earnings call, CEO Mike Roman conceded that 3M's organic growth had stalled at a paltry 0.4% against an expected 1% to 3%. This was followed by a tepid full-year guidance for organic sales growth, which Roman predicted would range from flat to a 3% decline compared to 2022.

The prognosis for 3M's end markets, another critical performance metric, is equally grim. As 2022 came to a close, Roman bemoaned the "rapid declines" in consumer-facing markets, including consumer electronics and retail. This adverse trend persisted into the first quarter of 2023, reinforcing concerns about 3M's vulnerability to weaknesses in consumer discretionary spending in its consumer-facing segment, as well as its industrial businesses such as closure and masking systems.

The situation has been further complicated by the slower-than-expected recovery in key economies, including China, on which 3M's full-year guidance hinges. Chief financial officer Monish Patolawala had optimistically assumed a broad-based economic revival in the second half of 2023, but with China's recovery flagging, 3M's end markets have fallen far short of ideal.

On the administrative front, 3M's restructuring efforts were dealt a serious blow when a key executive, Michael Vale, was abruptly dismissed shortly after being promoted to spearhead the turnaround plan. This upheaval is particularly concerning, given 3M's reputation for struggling to meet its financial targets over the years.

Other challenges facing 3M include potential legal liabilities associated with the use of certain chemicals. Amid these mounting pressures, even the company's well-regarded dividend is facing scrutiny and could be vulnerable under worst-case scenarios.

However, 3M's outlook isn't all doom and gloom. Despite a rocky start to 2023, there are still several factors working in the company's favor. The stock's valuation remains appealing, and a dividend yield north of 6% is undeniably enticing.

On the bright side, 3M managed to score an upgrade from analysts at Bank of America, who lifted their rating on the stock from Underperform to Neutral, citing a variety of "near-term positives." They pointed to the industrial group's June settlement with several U.S. public water systems over the use of persistent "forever chemicals," which are difficult to eliminate from human bodies or the environment. The settlement's size of over $10 billion fell below legal experts' expectations, prompting the analysts to observe that historically, stocks saddled with litigation risks tend to rebound following initial settlement announcements.

The Bank of America analysts also lauded 3M's cost-cutting measures, which include slashing headcount to compensate for the waning demand for consumer electronics. They asserted that these moves are "underappreciated" and that the company's financial guidance for the second half of 2023 and 2024 is "conservative."

Finally, they noted that the planned spin-off of 3M's healthcare business could "unlock value." However, the company's shares have sagged by more than 24% over the past year amid concerns about the "forever chemical" litigation and personal injury claims linked to earplugs made by affiliate Aearo Technologies.

At present, 3M's shares are still characterized by a short-term technical score of 34, suggesting that the stock has traded less bullishly over the last month compared to 66% of market stocks. The company's standing in the Conglomerates industry, which ranks 33 out of 146 industries, is better than 21% of stocks.

In terms of financial performance, 3M's revenue for the quarter ending March 31, 2023, was $8.031 billion, marking a 9.04% year-over-year decline. Gross profit for the same period stood at $3.418 billion, a drop of 14.61% from the previous year. Furthermore, operating income for the quarter was $1.241 billion, a significant 24.38% fall year-over-year. EBITDA for the quarter was $1.707 billion, an 18.71% drop from the same quarter in the previous year.

First, 3M's diversified business model, which spans numerous sectors, could cushion the blow from its underperforming segments. It's worth noting that the company's health care segment, in particular, has been a bright spot amidst the chaos, posting a respectable 4.5% increase in organic sales in the first quarter of 2023.

Second, 3M's robust research and development (R&D) pipeline could potentially catalyze a turnaround. With annual R&D expenditure exceeding $1 billion, the company has made a concerted push into growth markets such as personal safety, health care, transportation safety, and electronics. As these investments bear fruit, they could provide a much-needed boost to 3M's top-line growth.

Third, 3M's cost-cutting measures could drive margin expansion and bolster its bottom line. Despite the headwinds, the company has made significant strides in reducing its cost structure through initiatives such as the "4Ls" (Lean out, Logistical optimization, Low-cost country sourcing, and Labor arbitrage), which are projected to yield cost savings of $200 million to $250 million annually.

The company's planned divestiture of its healthcare business also bodes well for its financial health. The transaction, which is expected to close in the latter half of 2023, could unlock significant value and provide much-needed capital to pay down debt, invest in R&D, and return capital to shareholders.

As for the litigation overhang, it's worth mentioning that the company has made substantial progress in resolving these issues. In June 2023, 3M reached a $10.3 billion settlement with multiple U.S. water systems over PFAS contamination, resolving a significant source of uncertainty.

In summary, while 3M's performance in the first half of 2023 has been lackluster, there are several bright spots that could potentially catalyze a rebound in the coming quarters. Its diversified business model, robust R&D pipeline, and aggressive cost-cutting measures provide a firm foundation for future growth, while the planned divestiture of its healthcare business could unlock substantial value.
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