It has been about a month since the last earnings report for 3M (MMM). Shares have lost about 12.5% in that time frame, underperforming the S&P 500.
Will the recent negative trend continue leading up to its next earnings release, or is 3M due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.
3M Q2 Earnings and Sales Beat Estimates, Down Y/Y
3M reported better-than-expected results for the second quarter of 2019, with earnings and sales surpassing respective estimates by 7.8% and 1.9%. The company's earnings beat in this quarter marked an improvement from the negative earnings surprise of 10.80% recorded in the first quarter of 2019.
Its adjusted earnings in the reported quarter were $2.20 per share. The quarter's earnings surpassed the Zacks Consensus Estimate of $2.04. However, its bottom-line results decreased 28.3% year over year due to weak sales, rise in costs of sales and decline in operating results.
Weak Organic Sales, Divestitures and Forex Woes Hurt Revenues
In the quarter under review, 3M's net sales were $8,171 million, reflecting a decline of 2.6% from the year-ago quarter. Results were adversely impacted by a 0.9% decline in organic sales (results in automotive and electronics businesses were soft in the quarter), 0.8% negative impact of divestitures and 1.8% adverse impact of foreign currency translation, partially offset by 0.9% gain from acquisitions.
However, the company's net sales surpassed the Zacks Consensus Estimate of $8,021 million.
On a geographical basis, sales in the United States grew 1.7% year over year while that in the Asia Pacific decreased 3.5%. Europe, Middle East and Africa's sales declined 9.4% and that of Latin America/Canada slipped 2.9%.
Effective from the second quarter of 2019, the company realigned its business segments from five to four — including Safety & Industrial; Transportation & Electronics; Health Care; and Consumer. The segmental information is briefly discussed below.
Revenues from the Safety and Industrial segment totaled $2,961 million, decreasing 9% year over year. This decline was due to a 2.1% adverse impact of forex woes, 5% fall in organic sales and 1.9% negative impact of divestitures.
Revenues from the Transportation & Electronics segment totaled $2,452 million, decreasing 2.9% year over year. Results were adversely impacted by a 1.2% fall in organic sales and a 1.7% decline from forex woes.
Revenues from the Health Care segment were $1,831 million, rising 5.8% year over year. While organic sales grew 3.5%, unfavorable currency translation adversely impacted sales by 2.1%. Acquisitions had a positive 4.4% impact.
Revenues from the Consumer segment declined 0.5% year over year to $1,303 million. Forex woes had an adverse impact of 1.2% while organic sales were positively impacted by 0.7%.
Cost of Sales Increase, Operating Margin Falls Y/Y
In the quarter under review, 3M's cost of sales increased 2% year over year to $4,313 million. It represented 52.8% of net sales compared with 50.4% in the year-ago quarter. Selling, general and administrative expenses decreased 6.3% year over year to $1,686 million. It represented 20.6% of net sales versus 21.5% in the year-ago quarter. Research, development and related expenses increased 0.4% to $470 million. It represented 5.8% of the quarter's net sales versus 5.6% in the year-ago quarter.
Adjusted operating income in the quarter under review declined 29.1% year over year to $1,702 million. Adjusted operating margin was down 780 bps year over year to 20.8%. Adjusted tax rate in the reported quarter was 19.6% versus 20.8% in the year-ago quarter.
Balance Sheet and Cash Flow
Exiting the second quarter, 3M had cash and cash equivalents of $2,849 million, down approximately 3% from $2,938 million at the end of the last reported quarter. Long-term debt balance decreased 4.3% sequentially to $14,914 million.
In the reported quarter, the company generated net cash of $1,662 million, reflecting a year-over-year decline of 12.5%. Capital used for purchasing property, plant and equipment increased 15.3% year over year to $421 million. Free cash flow in the quarter was $1,241 million versus $1,534 generated in the year-ago quarter. Free cash flow conversion was at 110%.
During the first half of 2019, the company used $1,660 million for paying dividends to shareholders while repurchased $1,101 million shares.
3M worked on some restructuring and other actions to lower costs, boost productivity and increase cash flow generation (by lowering capital investments, reducing inventories and increasing indirect cost actions) in the second quarter. Related pre-tax charges recorded in the quarter totaled $148 million (or 21 cents per share).
Pre-tax annual savings are anticipated to be $225-$250 million while savings are predicted to be $110 million (or 15 cents per share) in the second half of 2019.
3M remains committed toward making investments in research and development as well as growth programs. Driving shareholder value is a priority too.
For 2019, the company maintained its adjusted earnings projection at $9.25-$9.75 per share. Tax rate is likely to be 20-22%.
Organic sales growth guidance has been reiterated too at (1)-2%. Acquisitions, net of impact from divested assets, will have a neutral impact while forex woes will likely hurt sales by 1%.
Net cash generated from operating activities is anticipated to be $6.3-$7 billion (down from previously mentioned $6.4-$7.2 billion) while capital expenditure will likely total $1.6-$1.7 billion (maintained). Free cash flow is predicted to be $4.6-$5.4 billion (down from the prior $4.7-$5.6 billion) while free cash flow conversion is maintained at 95-105%.
Further, shares worth $1-$1.5 billion will likely be repurchased during 2019. Return on invested capital will likely be 20-22% (same as previous).
How Have Estimates Been Moving Since Then?
It turns out, fresh estimates have trended downward during the past month.
At this time, 3M has a nice Growth Score of B, though it is lagging a lot on the Momentum Score front with an F. However, the stock was allocated a grade of C on the value side, putting it in the middle 20% for this investment strategy.
Overall, the stock has an aggregate VGM Score of C. If you aren't focused on one strategy, this score is the one you should be interested in.
Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, 3M has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.
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