Industrial giant 3M‘s (NYSE: MMM) stock is now yielding more than 4% and is very tempting for income-seeking investors. That’s fair enough. If your primary focus is yield, go ahead and buy the stock.
However, it might be a different story for investors looking for capital appreciation. It seems highly likely that management will have to lower full-year guidance on its next earnings call, so if you buy the stock, be aware there’s a high possibility of some negative near-term news flow. Here’s why that matters.
On the first-quarter earnings call, management left its full-year guidance unchanged despite revealing a host of headwinds. As a reminder, management is calling for full-year sales growth in the range of 2% to 5%, with adjusted earnings per share (EPS) in the range of $10.75 to $11.25.
During the earnings call at the end of April, management was invited to give more detail on the guidance but declined to indicate where it might end up within the ranges. That’s puzzling given that management discussed a variety of headwinds in the quarter. For example, it said 3M was making a slow start to the quarter. In addition, management acknowledged industrial production growth expectations had been lowered, and growth expectations for the Transportation & Electronics end markets had “moderated.” Consumer electronics/semiconductors and autos are key end markets for 3M, and both continue to face challenges.
Still, management maintained full-year guidance.
What happened recently
Fast-forward to the Bernstein Strategic Decisions Conference, and CEO Mike Roman had some disappointing updates for investors. Here are some of the things he said:
- “Right now, I think the outlook for automotive build rates is about 4% year-over-year improvement. We started the year at 9%.”
- On trading in the second quarter, management sees “about $300 million impact on revenue” from the lockdowns in China.
- Adverse foreign exchange movements will lead to 3% to 4% headwinds “versus 2% in our plan.”
- On supply chain challenges: “We thought we might start to see things get better as we got into the second half, but it really does look like it’s persisting”
- On raw material inflation: “Even in the second quarter, I think we’re $25 million to $50 million above what we had thought we would be facing.”
Finally, on inflation, Roman walked back comments he’d made earlier in the year when he raised the possibility that a slowing in the growth rate of inflation through the fourth quarter could mean a peak was about to hit. Unfortunately, he said, “We’re obviously seeing higher than our estimate for this year.”
Putting the commentary in context
The commentary suggests that 3M’s guidance is under threat. There are three main reasons. First, the $300 million in sales headwinds in the second quarter (presumably not baked into current guidance) is equivalent to almost 1% of 2021 sales of $35.4 billion. That immediately calls into question that high end of the full-year guidance for growth of 2% to 5%.
Second, the greater-than-expected raw material inflation of $25 million to $50 million will shave around $0.04 to $0.09 from EPS. On top of this, Roman said the combination of the sales headwinds and adverse foreign exchange movements would be responsible for around $0.30 in EPS headwinds in the second quarter.
Third, the admission that management was behind the inflation curve means it could also be late in pushing through price increases intended to offset inflationary pressures. Again, the result could be more margin pressure.
Does it all matter?
While it’s important not to get caught up in quarter-by-quarter movements if they obscure the long-term picture, 3M is a company that lost its premium rating due to a combination of disappointing operational performance and a failure to meet guidance.
It’s certainly not the only industrial company suffering from the vagaries of supply chain challenges and raw material cost inflation. However, whereas other industrial companies, such as General Electric, Stanley Black & Decker, Raytheon Technologies, Rockwell Automation, and Johnson Controls, have already told investors to lower their expectations, 3M is yet to cut its formal guidance. This is something to watch if you are buying into the stock.
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