Industrials And Safety & Graphics Continue To Shine For 3M

by Trefis Team
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3M (NYSE: MMM) narrowly beat expectations on both revenue and earnings in the second quarter, posting an EPS of $2.59 on sales of $8.39 billion. However, while the organic sales growth expectation for the year remains the same, the company trimmed the top end of its earnings guidance range yet again, $10.20 to $10.45 per share versus a prior expectation of $10.20 to $10.55, as a result of the divestiture of its communications markets business. This factor resulted in the stock falling 4%, before it recovered to finish the day 1% higher than the previous day’s close. 3M’s Industrials and Safety & Graphics divisions continue to be the growth drivers, while geographically, China, Hong Kong, and India posted double-digit growth rates. These trends are expected to continue through the year, although with slight variations in the third and fourth quarter performances.

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. 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 for our interactive dashboard on 3M’s Q2 performance 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 And India To Drive 3M In The Future: During the second quarter, 3M posted 12% growth in China, Hong Kong, and India. 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 workers in these regions, 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 and India. 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. Meanwhile, in India passenger vehicle sales were up almost 8% in the year ended March 2018. 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. Consequently, the impact of the steel and aluminum tariffs are expected to be minimal – approximately $10 million, or a penny per share on an annualized basis.

2. Pricing Growth Remains Strong: 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. While we didn’t think the company could top that, 3M, in fact, delivered 110 basis points of pricing growth in the second quarter. 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 remainder of the year. For the full year, 3M expects to attain 30 to 50 basis points of pricing growth, by marking its products above the inflation levels, and overcoming any raw material and foreign exchange headwinds.

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.

5. Roll-Out Of ERP Software: 3M has been in the process of rolling-out ERP (Enterprise Resource Planning) software throughout its organization, which can help it to improve productivity, increase efficiencies, decrease costs, and streamline processes. The company has largely completed this process in Europe, and is in the middle of implementing it in the U.S. In anticipation of this roll-out, a number of the company’s customers pre-ordered their purchases, which resulted in a 50 to 100 basis points of growth in the second quarter in the country. Since these sales would have resulted in the third quarter, the negative sales impact of the ERP roll-out will be felt in the third quarter.

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