Industrials

Can 3M's Conglomerate Structure Be Saved From the Wrecking Ball in 2020?

Jon C. Ogg

Published: October 25, 2019 11:59 am

Last Updated: January 30, 2020 2:04 pm

A rising trend has been for companies to have a specific purpose or target in their business. Simple business models, even if the underlying operations and management structures may be complicated, are just easier to sell to investors than widespread companies with many operations that have little or nothing to do with each other. In short, the investing community just does not want the conglomerates to be quite so conglomerated. 3M Co. (NYSE: MMM) has fallen from grace with a series of disappointing earnings to the point that the investment community no longer has much trust or faith in the company.

If you compare 3M to other conglomerates, it is in a far “less-bad” situation than General Electric Co. (NYSE: GE) but is not viewed as favorably as United Technologies Corp. (NYSE: UTX). GE is in the midst of continually downsizing, shrinking its “banking and finance” exposure, shrinking its high exposure to oil and gas, selling smaller non-core operations outright and even exiting its biotech operations within its health care operations. And United Technologies is committed to a merger of equals of sorts with Raytheon Co. (NYSE: RTN) to become an aerospace and defense focused player while simultaneously breaking out the Otis (elevators) and Carrier (air conditioning) units.

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The question to ask now is whether it’s time for 3M to become much more focused in individual units. Even after a restructuring effort, many people might have a very hard time identifying exactly what 3M does outside of its consumer-facing products. Will Wall Street start to demand that 3M breaks itself up into two or more smaller and more focused entities so that investors can more easily identify what they are invested in?

24/7 Wall St. has looked into the earnings notes and the forecasts, but we also have looked at outside analyst research calls to see what the top brokerage firms are telling investors to do with their shares. 3M is still technically under relatively new leadership, after Michael Roman was named as CEO in mid-2018 and the prior CEO, Inge Thulin, was named board chair. Its shares were closer to $196 at that time, or close to $188, if adjusting for dividends.

With earnings for the third quarter of 2019 released, 3M shares slid again on talk of slower economies in the United States and in China, as well as in automotive and electronics. The recent acquisition of Acelity may not have been a bad one, but in a conglomerate when the world wants more focused models to pick from, it did come with a negative impact of $0.15 against the earnings per share guidance in the fourth quarter. The company’s new guidance was for $2.05 to $2.15 in earnings per share, after that $0.15 hit, versus consensus estimates of $2.38 per share outside of items. The weakness in the areas above was included in the company’s guidance, but the so-called return on invested capital was lowered to a range of 18.5% to 19.5% from a prior 20.0% to 22.0%, and the new range of fiscal 2019 earnings was lowered to $8.99 to $9.09 per share from $9.25 to $9.75.

Unfortunately, an approximate $9.00 annualized earnings per share forecast and a $168.76 pre-earnings share price generate a valuation of close to 19 times current-year earnings forecast. That may not be a crazy valuation on the surface, but trying to count any 2020 earnings forecasts may simply be nuts at the current time, considering that all the problems may persist and the global growth story has remained one of concern and contraction more than growth and opportunity. 3M’s U.S. sales were lower than a year earlier, with a significant decline in industrial production. 3M is also in the midst of an environmental case and an internal investigation of business practices in China that investors have not previously had much concern over.

Credit Suisse maintained its Outperform rating and $178 price target on 3M, noting that the shares trade at a nine-year low against two key rivals and that the risk-reward skews positive.

CFRA maintained its Hold rating and $173 target price, noting concerns about slower revenue growth, tepid global growth, tariffs and trade wars, and steep acquisition costs.

Then the other firms that lowered targets or performance expectations need to be considered.

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Merrill Lynch maintained a Neutral rating and $175 price objective, but the firm lowered its 2020 earnings per share estimate to $10.00 from $9.75 and talked about persistent weakness in Safety & Industrial and in Transportation & Electronics. The analysts noted that it remains unclear what is driving declining margins and how or when the company will be able to get its margins back up at a time when its companywide ERP rollout is scheduled to last for at least another year, with limited opportunities for near-term improvements.

Morgan Stanley maintained its Equal Weight rating but lowered the target price to $165 from $173.

RBC Capital Markets maintained its Sector Perform rating and lowered its target to $164 from $170.

One issue that may complicate any efforts to target 3M for a breakup or from any pressure by a future activist investor or group is that 3M has one of the longest streaks of consecutive annual dividend hikes of all major companies in the Dow Jones industrial and S&P 500 indexes. Those dividend hikes might be harder to expect during a break-up, and expecting all the units to continue on that path would be harder as some areas of the business would be unable to provide cover for the troubled areas.

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The 24/7 Wall St. outlook for a 2020 turnaround after the second-quarter earnings also contained more concerns than opportunities at the time, and turnarounds become very problematic for companies if the economic growth story turns into an actual recession that the media had overly panicked the public into. 3M shares were closer to $175 at that time, and the S&P 500 is now within 1% of its all-time highs again.

Shares of 3M traded down 4.07% to $161.89 on Thursday after the earnings report, but Friday’s market gains in the first half of the day had shares up about 2.5% at $166.00. Its 52-week trading range is $150.58 to $219.75, after having peaked at just above $250 in early 2018.