Can Safety & Graphics Drive Growth For 3M In The Third Quarter?

by Trefis Team
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3M‘s (NYSE: MMM) stock is down considerably this year, from its high of $259 towards the end of January to $213 currently. While the company has reported broad-based growth and has largely met consensus expectations, the revision of its earnings guidance, as well as factors such as the China-U.S. trade war have resulted in its stock price taking a beating. The company’s organic sales growth forecast has been reduced to between 3% to 4%, from 3% to 5%, and its earnings guidance has been cut from $10.20-$10.70 per share, stated at the beginning of the year, to $10.20 to $10.45, due to higher than expected costs, a soft automotive market, and the divestiture of its communications markets business. These trends are expected to continue in the third quarter, though price increases should more than offset cost pressures. Meanwhile, Safety & Graphics is projected to continue its solid performance in the second half of the year, while geographically, China, Hong Kong, and India should continue to remain strong.

We have created an interactive dashboard based on our expectations for 3M’s performance in 2018, and have arrived at a price estimate of $216 for the company, which is roughly in-line with the current market price. You can click here for our interactive dashboard on 3M’s Expected Performance In Q3 And FY 2018 to modify the different assumptions, and arrive at your own price estimate for the company.

Factors That May Impact Future Performance

1. 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.

2. Cost Headwinds: While raw material headwinds are expected to be more than offset by the price increases, the management anticipates the headwind to be closer to the higher end of its guidance range of $0.05 to $0.10 for the full year. This is primarily due to higher than expected commodity prices and logistics expenses. Moreover, earlier, foreign exchange was expected to be $0.10 tailwind to the earnings. However, the dollar strength, particularly against emerging market currencies, should result in the FX impact on 3M’s earnings to be approximately neutral.

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 majority of the negative sales impact of the ERP roll-out will be felt in the third quarter.

6. Segment-Wise Expectation: While 3M had guided for a 3% to 5% organic growth in the Industrials segment for FY 2018, it is likely to be in the bottom half of the range as a result of a weakness in the automotive production market, particularly in China. On the other hand, in Safety & Graphics, the company expected 4% to 6% organic growth. Since in the first half the company has already garnered an 8% improvement, it is highly likely the growth will be toward the upper end of the range, with even the possibility of the company exceeding its expectations. 3M anticipates 1% to 4% increase in the Electronics & Energy segment, and with 3%  attained in the first half, the company performing well in the second half is entirely based on the consumers’ willingness to update their electronic devices. In Health Care, the company seems closer to achieving only the lower end of its 2% to 4% growth guidance, primarily due to the weak performance of its oral care segment in the U.S. and a poor showing of its drug delivery business. The Consumer segment is expected to perform as projected.

7. China Performance: The consumer-facing parts of 3M’s business have continued their robust performance this year, and this trend is expected to continue for the remainder of FY 2018. This includes the performance of its Safety & Security and Health Care business. However, its manufacturing and exports-elated business, particularly automotive in its Industrials segment, has shown considerable weakness this year. Consequently, growth from the region is expected to be close to 10%, from 10% to 15% expected earlier. Given the tariff retaliations 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 is expected to be minimal – approximately $10 million, or a penny per share on an annualized basis.

8. Reduced Tax Rate: As a result of the reduction in the corporate tax rate from 35% to 21%, 3M’s effective tax rate is expected to be 24% for FY 2018. When compared with the almost 36% rate the company had to pay in FY 2017, this should result in an enormous boost to the company’s earnings.

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