Can China Drive Growth For 3M In The Second Quarter?

by Trefis Team
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3M‘s (NYSE: MMM) stock is down considerably in the past six months, wiping out all of its gains of the latter half of 2017. While there were expectations for a really strong first quarter, and the company did deliver broad-based growth, its stock plunged in the aftermath, with the primary reason for this being the guidance revision. The organic sales growth was restated to be between 3% and 4%, from 3% and 5% earlier, resulting in a change in the adjusted earnings guidance to $10.20 to $10.55 per share versus a prior expectation of $10.20 to $10.70 per share. Higher than expected costs and a soft automotive market are the main contributing factors to the weaker outlook. The company is due to report its second quarter results on July 24, wherein an 8% revenue increase and flat earnings growth are expected.

 

We have created an interactive dashboard based on our expectations for 3M’s performance in 2018, and have arrived at a price estimate of $241 for the company, which is significantly higher than the current market price. Recent market volatility and a weaker outlook have been the main factors driving the stock down, as the core fundamentals remain strong. You can click here to modify the different assumptions, and arrive at your own price estimate for the company.

Factors That May Impact Future Performance

1. Growth In China To Drive 3M In The Future: During the first quarter, 3M posted 7% growth in developing markets, including 11% organic growth in China/Hong Kong. A number of trends in the region should ensure continued strong growth for the company in the years to come.

  • Safety and Security: 3M aims to provide safer work environments for Chinese workers, and in this regard, its portfolio of hearing protection, fall protection, and SCBA (Self-Contained Breathing Apparatus) through its new acquisition of Scott Safety, can be considered to be the next horizon of safety awareness for China. In 2014, China overtook the U.S. as the largest safety and security market in the world, and the growth has not slowed down yet. The demand for this segment is expected to improve with the growth of the infrastructure spending in the region. China alone is expected to need $28 trillion in infrastructure investment by 2040, which is more than half of Asia’s total needs, and 30% of global needs.
  • Automotive: The automotive industry has witnessed modest growth globally, with the growth in China production outpacing the overall growth, albeit at a lower rate than in prior years. According to the China Association of Automobile Manufacturers, in 2017, the production and sales of automobiles were 29,015,000 and 28,879,000 units respectively, up 3.2% and 3% year on year, respectively. In the future, a growing and richer middle class, and the potential of Tier 2 and Tier 3 cities, can be expected to drive growth. 3M manufactures over 400 products pertaining to this segment, such as auto body fillers, adhesives, cleaners, waxes, polishes, which can be expected to grow as the industry continues its strong march.
  • Healthcare: Developing countries bear the brunt of food-borne diseases, with high levels of hazards reported in the food available there. A number of studies have shown a higher prevalence of such diseases in developing economies, as compared to high-income countries. 3M is a leader in developing innovative solutions to help the food and beverage industry to optimize the quality of their products. The company manufactures food and beverage testing products to ensure the achievement of the highest food safety and quality standards. It also develops environmental monitoring programs to identify and eliminate sources of potential contamination.

Given the possibility of a trade war with China, one factor that may work in 3M’s favor is that the company has focused on local manufacturing, in the sense that it manufactures within China for its Chinese customers.

2. Pricing Growth May Not Be As Much As In The First Quarter: In Q1, 3M was able to deliver 70 basis points of pricing growth, and excluding the electronics businesses, selling prices were up 90 basis points, and were positive across all geographic areas. This marked 3M’s strongest underlying price performance in several years. However, given the recent rise in cost inflation and of crude oil prices, which impacts transportation and other input costs, the pricing power may be limited in the second quarter. For the full year, 3M expects to attain 30 to 50 basis points of pricing growth, by marking its products above the inflation levels.

3. Opportunity Presented By Automotive Electrification: This is a new and exciting space for many companies, with 3M uniquely positioned to do well since three of its businesses are in a position to benefit from the growth in this market. As part of its automotive business, 3M can work with automotive OEMs (Original Equipment Manufacturers) for developing designs and providing materials. Through its electronics business, the company will be able to innovate in consumer electronics, semiconductor manufacturing, and data centers to take advantage of this growth. Furthermore, its transportation and safety business can help to provide the next level of vehicle safety and vehicle control.

4. Acquisitions And Divestitures Aiding In The Progress: In June, 3M completed the sale of almost all of its Communication Markets Division to Corning Incorporated for $870 million. Earlier, the company purchased Scott Safety from Johnson Controls, which will help to strengthen its position in the attractive personal safety market. It has also sold its Identity Management business, its Tolling and Automated License/Number Plate Recognition business, and its Electronic Monitoring Business in its Transportation Safety division in order to focus on “connected roadways.” The company continues to look at acquisitions in “attractive” areas of its portfolio, while undertaking divestitures in the underperforming units.

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