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3M (MMM) Gains From Restructuring Moves, Costs Remain High

Zacks Equity Research

On Dec 26, we upgraded 3M Company MMM to a Zacks Rank #3 (Hold) from a Zacks Rank #4 (Sell). Going by the Zacks model, companies holding a Zacks Rank #3 have chances of performing in line with the broader market over the next one to three months.

What’s Favoring the Stock?

Fiscal stimulus provided by the Republic-led government and the December 2017 implemented corporate tax cuts supported the domestic business prospects of diversified operations companies in the United States like 3M. Moreover, the company is currently divesting its non-core communication businesses, in a bid to focus on the high-margin trading prospects. Notably, 3M anticipates securing earnings benefit of 40-45 cents per share in 2018, against such moves. In addition to these, we believe the company’s solid top-line growth trajectory will aid in boosting its profitability. For 2019, 3M anticipates earnings per share of $10.60-$11.05, higher than the $9.90-$10.00 predicted for 2018. Per our estimates, the company’s year-over-year earnings growth rate is currently pegged at 8.5% for both 2018 and 2019.

Solid demand for premium brands like Nexcare, Post-it, Scotch, Scotch-Brite and Scotchgard will drive 3M’s revenues in the quarters ahead. Notably, the company’s research and development (R&D) investments will likely aid in further solidifying its product portfolio and support top-line growth as well. Per our estimates, the company’s year-over-year revenue growth rate is currently pegged at 3.7% and 2.4% for 2018 and 2019, respectively.

From 2019 to 2023, 3M anticipates organic sales growth (local currency) to be 3-5%, bottom-line growth of 8-11%, return on invested capital to be 20% and free cash flow conversion to be roughly 100%. Also, the company intends to spend 30% of its capital on innovation investments, 30% on paying dividends, and the rest 40% for making acquisitions and repurchasing shares.

Existing Issues 

Over the past month, 3M’s shares have lost 11% compared with the 12.1% decline recorded by the industry it belongs to.

We notice that the company is currently plagued with severe supply-side challenges. Material cost inflation (on account of tariffs levied on U.S. imports), rising freight charges (due to shortage of truck drivers and soaring truck fuel surcharges), flaring up interest expenses and high retirement benefit cost have been escalating 3M’s aggregate costs.  The company's cost of sales jumped 5.1% and 2.5% in the second quarter and third quarter of 2018, respectively. Rising cost, if unchecked, will dampen 3M’s near-term profitability.

Moreover, 3M faces tremendous local competitive pressure, whether it is in Brazil, China, India or Indonesia. In order to hedge competitive pressure, the company has to invest significantly in R&D to locally develop and manufacture new products. These are likely to put pressure on the company's near-term finances and hence, adversely impact its profitability.

Also, we notice that on a P/E (TTM) basis, 3M’s stock looks overvalued compared to its industry with respective tallies of 18.3x and 15.0x. This makes us somewhat cautious toward the stock.

Stocks to Consider

Some better-ranked stocks in the same space are listed below:

Carlisle Companies Incorporated CSL carries a Zacks Rank #2 (Buy). The company pulled off a positive average earnings surprise of 11.90% in the past four quarters. You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

Federal Signal Corporation FSS holds a Zacks Rank of 2. The company generated a positive average earnings surprise of 21.18% in the trailing four quarters.

ITT Inc. ITT also carries a Zacks Rank of 2. The company generated a positive average earnings surprise of 5.72% in the preceding four quarters.

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