Why Did 3M’s Stock Fall After Reporting Its Second Quarter Earnings?

3M (NYSE:MMM) delivered a hit and a miss in its second quarter. While the earnings of $2.58 per share came in above expectations, the revenues of $7.81 billion were shy of estimates by $50 million. The company also narrowed its full year guidance to a range of $8.80 to $9.05, from $8.70 to $9.05 earlier.

Led by gains in the Electronics & Energy segment, which was on a decline for much of last year, the company was able to deliver positive organic growth of 4% in the quarter. All five of its segments reported positive organic growth – 8% in Electronics & Energy, 4% in Industrial, 3% each in Safety & Graphics and Healthcare, and 1% in Consumer. During the quarter, the company also made strategic investments of $178 million; $39 million of which were growth-related, and $139 million were portfolio and footprint actions. Such strategic investments are expected to be carried on during the remainder of the year as well, and will have an impact of $0.20 to $0.25 on the EPS. These actions are being undertaken to improve the productivity from the manufacturing and supply chain base in the future. Despite a relatively strong quarter, the stock price of the company took a hit, posting its “worst-ever daily price decline on record.”

So Why Did The Stock Price Decline?

1. Sales Miss- 3M missed consensus revenue expectations by $50 million. A couple of factors negatively affecting the sales growth were divestitures of non-strategic businesses and foreign exchange, which impacted by 1% and 0.6%, respectively.

2. EPS Guidance- While the company revised the lower end of its guidance upwards, the midpoint of the range, $8.925, trailed consensus estimates of $8.98.

3. Disappointing Core Pricing- While the company has resorted to price increases in the past to drive growth, this metric declined 0.3% in the quarter, and was down by 40 basis points in the US. In Asia Pacific, strong volume growth in E&E contributed to price declines, and in Latin America, where weak currencies contributed to price growth in the past, relatively stable currencies this time resulted in the drop. In the US, the company continues to expect the price growth to be closer to flat for the total year.

Margin Growth Led By Divestitures

On the face of it, a 360 basis point improvement in margins is very impressive. However, if we delve a little deeper, a majority of this expansion has been a result of the divestitures undertaken in the Safety & Graphics business, which improved its margins by 28.1 percentage points. Its other businesses, besides E&E, witnessed margin contractions. Once divestiture gains on its margins are discounted, the metric actually underwent a decline. In the second half of the year, the company expects its Industrials segment to post a 50 basis points margin improvement. This is expected to be driven by price increases, improved results from its productivity programs, and cost-cutting.

The company has been undertaking a number of strategic investments, slated to total approximately $400 million this year, which are expected to yield significant savings to the company. When such initiatives include steps like reducing the workforce, the payback is quick. However, when it involves optimization of its manufacturing or supply chain, such as what 3M has been doing recently, the fruits of this labor take a while to reflect in the margins.

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