Foreign Currency Headwinds Dampen Outlook For 3M

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3M (NYSE: MMM) reported a big miss in the third quarter, with earnings falling 15 cents short of expectations, and revenues coming in $280 million lower than anticipated. Sales fell 0.2% when compared to the corresponding quarter of last year, despite posting an organic growth of 1%, driven lower by 1.7 percentage points impact of foreign currency headwinds. This factor impacted the earnings negatively by $0.08 as the US dollar strengthened against many currencies throughout the quarter. This trend is expected to plague the company in the fourth quarter as well. For the full year, 3M now expects an earnings headwind from foreign-currency of  -$0.05 per share versus a prior estimated benefit of $0.10, implying a reduction of $0.15 per share versus previous expectations. Consequently, the company has lowered its earnings guidance to $9.90 to $10 against the previous range of $10.20 to $10.45.

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 higher than the current market price. We are in the process of updating our model based on the new guidance provided by the company. You can click here for our interactive dashboard on 3M’s Expected Performance In 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: 3M has delivered strong pricing growth in the first three quarters of this year. 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. This was topped in Q2, with the company delivering 110 basis points of pricing growth, followed by 120 basis points increase in the third quarter. Although 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 Q4, the company should be able to offset this.

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 -$0.15 per share versus a prior range of negative $0.05-$0.10 per share for the full year. This is primarily due to the tariffs and the higher than expected commodity prices and logistics expenses. Moreover, earlier, foreign exchange was expected to be a $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 -$0.05 per share.

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 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 was felt in the quarter (-250 basis points impact), with a slight impact expected in Q4. This deployment is projected to generate between $500 million and $700 million of operating income benefit by 2020.

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 a 6% 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 nine months, the company performing well in the final quarter 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 between 20% and 21% 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. Moreover, the company is also undertaking share repurchases, with $1.1 billion returned to shareholders in the quarter. For the full year, gross share repurchases are anticipated to be in the range of $4 billion to $5 billion.

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