3M Company (MMM): Q2 2022 Results, Spin-Off And Litigation; What’s Next?

Quarterly results

3M’s quarterly results were positive compared to Wall Street analysts’ forecasts, but they are far from the company’s positive economic picture. 3M (NYSE:MMM) beat analysts’ estimates both on the EPS (adjusted) side, declaring $2.48 per share, down 4.3% from the same period a year earlier, and on the revenue side, reporting $8.7 billion, a drop of about 3% from the previous year’s quarter and exceeding analysts’ forecasts of $8.58 billion in revenue.

The strengthening of the dollar harmed the company by 4% on sales. In addition, organic growth was only 1% from the previous year due to reduced demand for single-use respirators and the impact of Chinese COVID-related closures. As a result, operating cash flow was $1.1 billion, down 40% from the previous year, while adjusted free cash flow was $1.0 billion, down 41% from the prior year. General and administrative expenses increased significantly during the quarter, causing operating margins to shrink.

Guidance update

3M, due to the strengthening dollar and worsening macroeconomic conditions, has updated its full-year sales and earnings expectations.

• Total sales growth is expected to be between 2.5 to 0.5%, up from previous guidance of 1 to 4%.
• Organic sales growth is now expected to be between 1.5 to 3.5%, compared with previous guidance of 2 to 5%.
• GAAP earnings per share are expected to be worth between $7.32 to $7.82, compared with $9.89 to $10.39 in previous guidance.
• Adjusted earnings per share are expected to be worth between $10.30 to $10.80 versus $10.75 to $11.25 in previous guidance.

The Spin-Off of Health Care Business

Yesterday, July 26, 3M announced plans to spin off its Health Care business, creating two public companies. Health Care will be a leading global diversified healthcare technology company focused on wound care, health informatics, oral care, and biopharmaceutical filtration. Health Care had revenues of about $8.61 billion in 2021. The idea of this spin-off is to create a leading healthcare technology company with a deep and diversified portfolio of trusted brands.

Health Care is currently expected to be spun off with net leverage of approximately 3.0x – 3.5x EBITDA and positioned for rapid deleveraging. In addition, New 3M plans to retain a 19.9% stake in Health Care, which will be monetized over time. 3M expects to complete the transaction by year-end 2023.

The litigation related to Combat Arms Earplugs

3M also announced that it is taking action to settle litigation over Combat Arms version 2 earplugs (“Combat Arms earplugs”). The litigation concerns the sale of Combat Arms version 2 earplugs that caused hearing damage to combatants who wore them.

As stated in the company’s statement, “Aearo Technologies (which was acquired by 3M in 2008 and has since operated as a wholly owned subsidiary of 3M) and related entities (“Aearo Technologies”), all of which are wholly owned subsidiaries of 3M, have voluntarily initiated Chapter 11 proceedings, seeking court oversight to help establish a trust — funded by 3M — to efficiently and equitably resolve all claims they believe are entitled to relief.” 3M then pledged to fund the trust to the tune of $1 billion and to commit an additional $240 million to fund anticipated expenses in the case.

Stock performance and valuation

The stock has lost 20% since the beginning of the year. However, the market seems to have positively welcomed the quarterly results, registering +5% in the first trading hours. Negative expectations on this stock and litigation-related doubts had sunk the stock, and the company’s latest press releases have reduced investors’ doubts.

The company right now is discounting a slowdown in the U.S. economy but is still far from discounting a significant recession. If we compare the current PS, we see that the company only touched lower values between 2008-2009 and 2011 and 2012. Even if we look at the PB, we can see how values have returned toward the historical average, where the extremely high values reached in 2018.

The debt condition is not excellent, with cash and marketable securities amounting to 3 billion and long-term debt exceeding 14 billion. However, although 3M’s business will undoubtedly suffer in the event of a recession, it should be able to secure significant cash flows that are also capable of paying the dividend that the company pays, which now is equal to a dividend yield above 4%.

Conclusions

3M has demonstrated its resilience in various economic environments during expansion cycles and even deep recessions. It is a company that pays an excellent growing dividend, with a business that will benefit significantly from increased e-commerce but, at the same time, is very well diversified. Spinning off part of the business could allow Health Care to grow more. In addition, determining the damage caused by the Combat Arms earplug litigation lessens the uncertainty about this stock. This stock may be an excellent addition to a portfolio looking for stability or a steady yield. However, we need to monitor economic trends because there is still room for a contraction in multiples.