3M Company: Still Cautious Sub $100
Contributor since 2011 / 23948 Followers
Summary:
- 3M continues to be under pressure.
- The company has seen a soft first quarter amidst continued (and even new) legal worries.
- I am very cautious given the backdrop of all of this.
josefkubes
Shares of 3M Company (NYSE:MMM) continued to be under pressure, as shares have fallen below the $100 mark on the back of continued headwinds to the business, and on the litigation front.
In April, I concluded that uncertainty prevailed in the case of 3M, due to lingering legal concerns and lawsuits around PFAS, hearing protection and masks. These headwinds come amidst softer underlying performance, the divestment of the Food Safety business and anticipated closing of PFAS factories.
A Recap
For a very long time, 3M Company deserved the right to operate as a conglomerate, at least that was the case in the past. At the same time, the company was quite good at allocating capital, as the company thereby avoided the famous conglomerate discount, although that reputation has subsequently gone out of the window.
A $100 stock in 2013 jumped to $250 in 2018 on the back of the America First policies employed by President Trump at the time. This was followed by an expensive $6.7 billion deal for healthcare firm Acelity, while the company sold many businesses (on the low), as the buy high, sell low strategy reminded me of General Electric Company (GE) to some extent.
Despite these alternations of the portfolio, the company posted record sales of $35 billion in 2021 with earnings trending around $10 per share, with shares trading around $200 per share at the time. That performance looked good, but remember that 3M was already a $31 billion business a decade ago, indicating that strong growth was no longer seen in recent years. On the positive side, net debt of $12 billion was very manageable with EBITDA approaching the ten billion mark, as shares started to fall during 2022.
This came amidst general market uncertainty about the economy, inflation and higher interest rates. Moreover, the company announced hundreds of millions of settlements related to PFAS issues in Belgium. The company furthermore merged its food safety business with Neogen Corporation (NEOG) as the share price performance of the merged business has been a disaster subsequently. More lawsuits arrived after the company aimed to ring-fence liabilities related to its Aearo Technologies liabilities in relation to defective combat earplugs.
The combination of all of this cast continued pressure on the shares as the underlying performance was lackluster, but moreover there were a lot of issues on the legal front, many of which will take years and are likely costly (the question is how much) to resolve. In the meantime, the company announced to shut down PFAS production activities in the near term to halt the increase of new liabilities, all while the operating earnings performance was cut to just above $10 per share.
What Happened?
In January, 3M Company posted its 2022 results, a year in which sales fell from $35.4 billion to $34.2 billion while adjusted earnings fell from $10.73 per share to $10.10 per share. GAAP earnings were similar as the company recorded a big gain on the Neogen deal, offset by a $2.5 billion charge related to all the legal items, as the net debt load of $12 billion was pretty flat.
The issue is that the divestment of the Food Safety business and closure of the PFAS activities made that adjusted earnings for 2023 were seen at just $8.50-$9.00 per share, as the legal issues are excluded in these legal costs. That is an issue as the company continues to pay out a $6 per share annual dividend, resulting in a steep 70% payout ratio (based on adjusted earnings) with little potential to deleverage here. Moreover, no real progress was made on the legal front, as the $1.2 billion deal for Aearo has been a real headache.
Continued Uncertainty And Bad News
With uncertainty being high and the 2023 guidance being largely underwhelming, this is still a hard stock to see upside in for the near term. As the business keeps melting in terms of size and earnings power, while the dividend commitments remain high, and high litigation costs will appear, I see a lack of growth and likely increase in debt over time, although that leverage ratios are relatively low right now.
The issue is that the range (and timing) of the costs of litigation is so wide that literally all options are on the table, ranging from financial difficulties to massive upside for the stock, but this is mere speculation here.
The company posted first quarter results by the end of April, as this earnings release came amidst some changes at the top leadership team. The company reiterated the full year guidance with sales down by about 4% and earnings seen between $8.50 and $9.00 per share (adjusted earnings those are).
After first quarter adjusted earnings came in at $1.97 per share, it seems safe to say that risks to the earnings outlook are seen to the downside. Net debt was pretty flat at $12 billion as the company-maintained profitability and halted share buybacks. At the same time, adjusted EBITDA continues to melt as an $8 billion number looks about fair this year, pushing up leverage ratios to 1.5 times.
Trying to offset some headwinds, 3M announced that it will cut another 6,000 jobs across the board and globe, on top of the 2,500 positions made redundant in January. Pre-tax charges are seen at $700-$900 million, with a payback period seen around a year, as costs synergies are roughly equal to the charges incurred.
Early in May, 3M announced a small deal, selling its dental local anesthetic portfolio, a business located in Germany. 3M will fetch a $70 million price for the operations while losing another $30 million in sales, albeit that it is equal to just 0.1% of sales, as that deal is not going to move the needle.
Towards the end of May, more bad news was announced as the Dutch government is looking to hold 3M Company liable for the PFAS damage caused (actually by the Belgium operations) whose water flows through the Netherlands, as the impact of this has likely not been priced in yet, and might create another legal headache.
Still Cautious
Amidst all these moving trends, including continued operational softness and continued legal overhang (likely a new legal battle), it is simply very hard to get upbeat here about 3M Company, with the attempt to restructure the business not making me upbeat yet.
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