3M Earnings Preview: Unfavorable Foreign Exchange Fluctuation To Weigh On Results

3M (NYSE:MMM) is set to announce its second quarter results on Thursday, July 23. ((Q2 2015 3M Company Earnings Conference Call, July 23, 2015, 3M’s Event Details)) One of our primary concerns for this quarter’s results is the impact of foreign exchange headwinds. 3M generates a little under two-thirds of its net sales from outside the U.S., making it very susceptible to foreign currency fluctuations. With the U.S. dollar remaining strong through the second quarter, 3M’s top line is likely to have suffered. However, on an organic local currency basis, which excludes the impact of foreign currency fluctuations and one-time charges, we expect to see growth across all five of 3M’s business segments – Industrial, Safety and Graphics, Health Care, Electronics & Energy, and Consumer.

In the previous quarter, 3M reported a 3.2% decline in revenues, reaching $7.6 billion. ^[1] However, on an organic local currency basis, revenue grew 3.3%. Despite the 0.7% decline in net profits, 3M still managed to post growth of 3.4% year-on-year in its earnings per share, to reach $1.85, thanks to its $886 million share repurchases. Despite this, investors were disappointed by the lowered revenue and earnings guidance for the year on account of foreign currency headwinds.

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FX Headwinds To Eat Into Top Line

At the beginning of the year, 3M announced that it had taken certain measures that will help reduce the impact of the foreign currency headwinds. ^[2] 3M entered into currency hedging contracts with a tenor of 24 months, as opposed to its general practice of 12 month contracts, in order to safeguard against unexpected changes in foreign exchange rates. The company also planned to raise product prices to offset the impact of weak currencies, a strategy that 3M has used in the past and is one of the driving factors behind its pricing. The company also looked to localize production; for example, in order to cater to its customers in Europe, it would utilize its production capacity in Europe and avoid having to import from regions with stronger currencies compared to the euro.

Despite its preparations, a strong U.S. dollar hurt the company’s top line by 6.5% and reduced its pre-tax earnings by $0.10 per share. ^[3] We expect to see a similar impact on 3M’s second quarter results as well.

Given the expectations of a strong U.S. dollar, 3M lowered its revenue guidance in the first quarter. It expects to see a 6-7% decline in revenues, compared to its earlier estimates of a reduction of 4-5%. ^[2] It also revised its expectations for the impact of foreign currency translations from $0.20 per share to $0.35-0.40 per share. This will result in estimated earnings per share of $7.80-8.10, compared to 3M’s previous guidance of $8.00-8.30.

Electronics and Energy, Safety and Graphics, Health Care Drive To Growth

Currency fluctuations aside, we expect 3M to post strong growth across all its segments, with the Electronics and Energy, and Safety and Graphics segments growing the strongest.

Sales of 3M’s Electronics and Energy segment have been growing primarily due to its display materials. 3M’s display materials include films that help enhance viewing pleasure on devices with displays and adhesives that help bonding display parts, lenses, LCDs, and touch screens. The sales of these products are highly dependent on consumer electronics sales.

In 2014, the U.S. Consumer Electronics industry generated $217 billion. ^[4] The industry is expected to cross $223 billion in 2015 as a result of the growing demand for smartphones, tablets, and LCD, UHD and OLED TVs, with the declining fuel prices facilitating such purchases as it would help leave more disposable income in the consumers’ pockets. This trend should have helped bolster sales of 3M’s Electronics and Energy segment in the second quarter.

Safety and Graphics’ sales are primarily driven by personal safety products such as respirators, personal protective equipment, head and face protection, body protection, hearing protection and protective eye-wear. Of late, the deteriorating air conditions in China are becoming a concern, because of which we expect to see a rise in sales of 3M’s respirators in the second quarter.

We also expect to see a rise in sales of personal protective equipment driven by increasing regulatory focus on worker safety across both developed and developing countries. In order to capitalize on this growing market, 3M announced that it will be acquiring Capital Safety, a leading global provider of fall protection equipment, from KKR for a total enterprise value of $2.5 billion. ^[5]

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1. 3M’s Q1 2015 Earnings Press Release, April 23, 2015, 3M’s Press Release [↩]
2. 3M’s (MMM) CEO Inge Thulin on Q4 2014 Results – Earnings Call Transcript, January 27, 2015, Seeking Alpha [↩] [↩]
3. Q1 2015 3M Company Earnings Presentation, April 23, 2015, 3M’s Presentations [↩]
4. Industry Sales Data, www.ce.org [↩]
5. 3M to Acquire Capital Safety, June 23, 2015, 3M’s Press Release [↩]