Why Investors Are Looking at the 3M Turnaround Much Closer for 2020

3M Co. (NYSE: MMM) has had a slate of challenges for the past year and a half. After everything was chugging along to perfection in 2017, then 2018 and 2019 were rather difficult for 3M, when the market for most Dow stocks kept rising. With the latest earnings report, many shareholders and observers who have considered becoming shareholders may have reason to believe that the worst is over for 3M.

Before delving into the solid part of its second-quarter earnings and analyst reactions, it’s important to outline the ongoing problems that remain for 3M. The conglomerate is involved in an environmental issue that is still hard to quantify, but it could be in the billions of dollars over time.

Overall demand has been low for more than a year, largely due to weakness in China, and manufacturing weakness is playing its role too. 3M’s Electronics and Energy sales have suffered since the U.S./China trade war began, and electronics-related growth has been hit by soft end-market demand in consumer electronics and factory automation. 3M’s shares peaked at close to $250, falling to near $220 more recently and was last seen closer to $175. The S&P 500 was up close to 20% in 2019 alone.

Despite the troubles, 3M continues aggressively returning capital to shareholders, and it has one of the best dividend hike streaks of all major U.S. companies. In the second quarter alone, 3M paid $830 million in cash dividends to shareholders and repurchased $400 million of its own shares.

3M’s report of $2.20 in earnings per share and $8.20 billion in revenue sounded great compared to the Refinitiv consensus estimates of $2.05 per share and $8.03 billion. The problem is that those stack up against $3.07 in earnings per share and $8.39 billion in revenues during the second quarter of 2018. In short, a drop of just 2.4% in total sales ended up with a drop of 28% in per-share earnings as margin has compressed.

In the second quarter of 2019, the conglomerate’s total sales grew 5.8% in Health Care, with declines of 0.5% in Consumer, 2.9% in Transportation and Electronics and 9.0% in Safety and Industrial. For the full year, 3M has most recently projected that earnings will be in the range of $9.25 to $9.75 per share, with an organic local-currency sales loss of 1% to 2%. Consensus estimates at the time of the report called for earnings of $9.39 per share and revenue of $32.44 billion for the year.

3M now yields about 3.3%, and its consensus analyst target price has risen to about $180.50 from under $178 prior to earnings. That might not sound like much of an analyst upgrade brigade, but analysts and investors rarely pile all in on any turnaround situation.

Analysts on Wall Street have started to get a bit less negative on 3M since its report. Morgan Stanley maintained an Equal Weight rating on 3M and raised its target price to $177 from $172. Credit Suisse reiterated its Outperform rating and raised its target to $194 from $180, while RBC maintained its Market Perform rating and $179 target.

Mike Roman, 3M board chair and chief executive, commented:

I am encouraged by our company’s progress and performance in the second quarter. Our execution was strong in the face of continued slow growth conditions in key end markets, as we effectively managed costs and improved cash flow. Moving ahead we remain focused on continuing to drive operational improvements, investing for the future and delivering for our customers and shareholders.

The turnaround from 3M remains a long-term project. If the economy continues to weaken rather than improve, and if the Federal Reserve’s rate-cutting cycle that just began proves to be a dud, it’s very possible that 3M could have more time ahead in the penalty box. That’s the problem of having a turnaround in a good market and good economy. Imagine how bad things would be if times were tougher. 3M is currently valued at more than 17 times a blended earnings estimate of 2019 and 2020 (with its earnings still expected to be under 2018 levels), and for a turnaround that implies that earnings per share may have to rebound faster for this “valuation discount” to merit what is effectively an at-market multiple.

3M was trading just under $175 at the closing bell on Thursday, with a $100.5 billion market capitalization and a 52-week trading range of $159.32 to $219.75.