3M Company (MMM) Earnings Call Transcript & Summary

Good morning, everyone. And welcome to day 2 of the Goldman Sachs Industrial and Basic Materials Conference. I am Joe Ritchie, I am the head of the U.S. multis coverage at Goldman. And very, very happy to kick off the day today with 3M. Before we get started, however, just required to make certain disclosures in public appearances about Goldman Sachs' relationships with companies that we discuss. The disclosure relates to investment banking relationships, compensation received or 1% or more ownership. We're prepared to read aloud disclosures for any issuer upon request. However, these disclosures are available in our most recent reports available to you as clients on our firm portals. Also, the views stated by non-Goldman Sachs personnel do not necessarily reflect those of Goldman Sachs. With that just rules for the road, if you guys have any questions for me, you can send me questions via the web link or feel free to shoot me an e-mail at [email protected]. So with that, 3M, very happy today to have Nick Gangestad, CFO of 3M. Nick, thanks so much for joining us today.

Thanks for having me, Joe. It's good to be here.

Great. So Nick, maybe before we kind of get started on the trends update that you provided today, and thank you for that, really appreciate it, maybe we'll just kind of start off the conversation with the N95 respirators. So first off, you guys have been working behind the scenes just to make sure that health care workers globally have access to N95 masks. So just wanted to say thank you for that, to start this off.

Thanks, Joe.

Yes. And then so just maybe kick along this theme, right? So in January, you doubled your global output to 1.1 billion. That includes roughly, call it, 35 million per month in the U.S. And last week, you announced DoD contracts that now allow you to almost triple your capacity in the U.S. to, call it, 95 million respirators or 1.1 billion respirators in the U.S. alone. So I know that you have plans in place and you're making investments to get to 2 billion by year-end. I'm just trying to understand like as you're putting all of this capacity in place like how are you thinking about this opportunity longer term because I think of this business as being, call it, roughly like a $600 million business for you. And based on all these capacity expansions, it seems like it can be a lot bigger than this. So maybe just start there, and then we'll take the conversation from there.

Great. Thanks, Joe. And as you know, 3M has been attacking this pandemic from all angles, doing all we can to be supporting health care workers and first responders. And as you mentioned, with the increases in capacity that we're investing in, we're expecting to, by the end of this year, to be able to be producing at a run rate of approximately 2 billion respirators per year. Now to the heart of your question, Joe, of what do we think this is going to look like long term. This is an unprecedented surge we're seeing. We've seen other cases in our history where we see surges, but I would call this one unprecedented in demand for our N95 respirators. And there is a period of time in which we think demand is clearly going to be outpacing supply. And then -- but as they go to the long term, I think 2 factors are going to play an important part of this. First, I think it's important for you to understand that typically, about 90% of everything we produce goes to our industrial and consumer markets, and that's actually inverted right now, where about 90% of everything we're making is going to health care and first responders. So as economies reopen, we do expect to see increasing demand from our industrial and consumer customers and we're aiming to balance that distribution appropriately as we move forward. Second, we also think pandemic preparedness is going to be an important topic around the world and that also could be leading to continued demand for new stockpiles. Now as we've done in the past, when we've increased capacity, when demand normalizes and the surge capacity is no longer needed, we would expect to be idling lines and have them ready for the next, what we internally call, x factor event where we would need it. So Joe, that's how we're preparing and planning for this.

Got it, Nick. That's super helpful. I guess maybe just following along those lines and you're just thinking about the impact that it could have this year, for example, so I referenced in the question that it's roughly a $600 million business for you today. How big could this business be for you today? And then also, just in your comments, so the fact that you're going to be able to be kind of selling this into both the industrial and consumer market, is it fair to assume that this is kind of like a good multiyear opportunity for you guys?

Yes. Again, to project beyond this year, I think there will be a number of factors that would influence it, and Joe, I'm not ready to make any predictions about '21 and beyond for this. But for this year, so for instance, in the first quarter, we said, for the total company, we saw it increasing our revenue approximately 1%. And in the second quarter, we saw it likely to be increasing our total company revenue by 150 basis points, 1.5%. Based on what we're seeing now, we think that 1.5% is going to go up. It could be double that, that it could be about a 3% impact to our total company growth in the second quarter.

Okay. Great. That's super helpful and clear. And I know this has been an evolving market, so trying to extrapolate into next year is tough. But appreciate the commentary, at least for 2Q. So maybe that kind of brings us to the next topic, which is really what you guys were seeing in April. And so at a high level, when I took a look at the regional breakdown, it looked fairly aligned with expectations. I think Americas and Europe was maybe a little bit better, and perhaps Asia maybe a little bit worse. Maybe just touch on the dynamics that you're seeing across the different regions, and then we'll kind of dig into the specific verticals.

Yes. I'll reiterate a little because I'm not going to assume everyone has read our press release there. So for the month of April, we saw organic sales decline of 12%. And for the month stand-alone, the demand for disposable respirators related to COVID-19, we think, contributed approximately 3% positively to April's organic growth. And that 3% we think we'll be seeing a similar impact throughout the entire second quarter from this disposable respirator impact. Geographically, Asia Pacific was down 5% and that included China, up 7%; and Japan, down 5%. EMEA, our organic growth was down 12%. And across the Americas, our organic growth was a negative 17%. The month did end a little better than what we were foretelling on the -- on our earnings call in April. And most of that being a little better is due to a bit stronger respirator revenue that we were seeing, particularly in the last week of the month. So Joe, go ahead with your question.

Got it. Yes. No. Yes. For sure. So maybe specifically, why don't we touch on Asia specifically. So China sales looked like positive 7 for the month of April, but Asia Pac down 5%. I think you guys were trending towards Asia Pac up a little bit in April when we got the last update from you. And so maybe just talk a little bit about some of the headwinds that you're seeing there, I'm assuming most of that is Japan. But any color around that would be helpful.

Yes. China ended very much as we expected. The biggest delta where we were seeing deteriorating revenue was in Japan. And so, Joe, you're right, that's the biggest swing factor we were seeing late in April in Asia Pacific.

And then I guess maybe talk a little -- can you give a little bit more detail around what's happening in Japan with the lockdowns. And there's been some discussion around of reacceleration or second wave of the virus there and whether that kind of extends the lockdowns and the weakness that you're seeing in Japan specifically?

Yes. What we were seeing in Japan, our Transportation and Electronics business, we're seeing noticeable declines there. We were also seeing declines in our Safety and Industrial business. In fact, we were -- and Health Care, as elective procedures are being delayed or canceled in Japan as they are in much of the world. Those are all trends that we were seeing in Japan in April and continuing into May. So I wouldn't say there's anything in particular going on, any particular message there of something in Japan. I'd say it's a reflection of what we're seeing in much of the world.

Got it. Okay. And maybe just in China. And I know you guys sell through distribution. But I'm just curious whether you think that kind of the uptick in China is now sustainable? Or whether you think there was some pent-up demand potentially or catch-up from a lower growth rate actually just normalizing? Just any color around that would be helpful.

Yes, Joe. I think the clearest answer is we don't know the mix of that. We think it's a combination of both, that there's been some restocking in the channel and some -- rebound in some demand. But that's partly why we're planning to be sharing revenue monthly to give that transparency that we don't have. I wouldn't necessarily say the 7% growth is the new normal for China. That's what we saw in April and as we see May and June come together, we'll share that of what we're seeing in China. But right now, that's one of the things we're watching to better understand what's the underlying demand in China as well.

Got it. No, that makes a lot of sense, Nick. And I got this question from the audience. So I guess -- and I think it's top of mind for a lot of folks. A lot of folks are trying to compare the reopening in China to developed markets and they take a look at the -- at that positive trend number that you just posted in China and want to know when we start to reopen here in the U.S. and in Europe, is it -- can we extrapolate that the U.S. and Europe could get to positive growth fairly quickly as well?

Yes. Joe, I wouldn't jump to being that optimistic yet. I would -- I think it's 1 month of data. And I don't necessarily think it's wise to assume this is a parallel that will go on in every part of the world. Each area has different underlying factors of what's going on in their economy, what's happening with COVID-19. So while I see -- it's promising to see China having -- posting growth in 1 month, I won't necessarily take it as a trend that you can very quickly extrapolate for China itself or for the rest of our businesses going forward.

Yes. No. That's fair. Nick, I think in the release, you kind of also -- you touched on all the different parts of your business that were trending kind of positive and you threw out like personal safety, the piece of the electronics business on semis and data centers and then other areas like oral care and auto OEM that are clearly more negative. I guess, as you think about your businesses and if you were to kind of put things into 3 buckets, let's say, the first bucket is holding up well now and will continue to post the recovery. The second bucket is businesses that are down a lot now, but could recover quickly. And maybe the third bucket being businesses that maybe will take longer to recover. You look across your portfolio, can you maybe kind of take different pieces of your portfolio and put it into those three buckets?

Yes. Thanks, Joe. Your question, I think, really highlights the value of the 3M portfolio and the diversity of our portfolio that as we do business around the world in different markets, we clearly are seeing mixed impact on different parts of our portfolio. And this, I think, is really capturing the strength of 3M's portfolio strategy. So as you mentioned, there's places where we're seeing strength. We're seeing strength in personal safety; home improvement, people working on improving their homes, so things like ScotchBlue tape or air quality solutions like Filtrete, we're seeing strength there; retail cleaning, products, food safety, biopharma filtration. Those are the type that I would say are holding up well and we continue to expect them to hold up well as we go through this. The places where we're seeing the biggest weakness right now, Joe, you mentioned oral care like -- we didn't put it in the press release, but I'll share it here. We saw our oral care business down approximately 70% in April. And that's very much aligned with what we were expecting as dentists and orthodontists office in much of the world being shut down right now. Automotive and also seen auto builds in the second quarter being down dramatically, and that's impacting our automotive business as well as general industrial. And with the businesses and schools not -- people not in the workplace, obviously, what we're selling through our stationery and office channel, those stationery and office products, we're seeing a big decline there. Now as far as your bucket-izing this, those businesses that are down most sharply, the pace of their recovery, Joe, is really going to depend on how those end markets come back. That will impact what we see for a recovery. So it's really, in our view, tied to the pace at which elective procedures come back in our medical business, the degree to which dental offices reopen, the pace at which automobile manufacturers resume their production. And that's going to be driven by consumers and them buying vehicles. And then overall general opening -- reopening up of manufacturing. So across those markets, the circumstances are going to vary based on those -- many of those factors I just laid out. The way we're approaching it is we are planning for multiple scenarios and then different timings for those things that we just laid out there. And our approach is we'll manage it as it comes depending on how fast elective procedures come back, how fast automobile production comes back. So I'm not going to like put all our businesses in those 3 buckets, but I'll say it's largely going to be driven by the end markets that our businesses are lined up with.

Yes. No. That makes a ton of sense, Nick. And for what it's worth, I mean, auto is an end market that, in my conversations with investors, that's an end market that folks feel like will snap back. Now it's going to be down a lot, but could be an end market that can snap back pretty quickly sequentially. And then oral care. Yes, again, I never thought I'd say this, but I'd be looking forward to going to see my dentist when this is all said and done. But anyhow, so -- but you know what, it's a good segue actually because you mentioned that commentary just around you're planning for different scenarios, right? So from a cost savings perspective, you guys outlined $350 million to $400 million in 2Q savings. My understanding is most of these actions are temporary in nature. You're not laying off any employees. How are you thinking about this number and potentially just the carryover effect for this year into 3Q and 4Q?

Yes, Joe. You are correct that a lot of these are not involving -- most -- almost all of this is not involving like restructuring actions where we are laying off employees. And as you know, our top priority is on the safety, well-being of our employees. And -- but there will be certain of these cost savings that in almost every scenario will carry forward. For example, travel expenses for us, our internal amount we spend on travel, we expect that to remain low for the foreseeable future. So there's a number of these cost categories that we are seeing down. It is a fast-moving environment and we adjust this based on what we're seeing. And some -- many of them, we can see continuing them into the third or fourth quarter. And some of them, we're prepared to relax if we're seeing a more dramatically evolving or returning economy. So I'd say there's a degree of flexibility that we can continue with that. There's also a flexibility that as we -- if we see things deteriorate further, we are monitoring that and prepared to act with other actions that we think would be necessary.

So just on that point and potential actions, I guess, at what point do you potentially consider other actions and then secondly -- more structural actions? And then secondly, like when I think about 3M, I think about it as being a fairly lean organization to begin with. Where do you see the most opportunity to reduce costs if it comes to that?

Yes. So as a reminder on that, Joe, we took structural actions last year given the challenging growth environment we were seeing in 2019 around China, the automotive industry and the electronics industry. Relative to further actions, I'd say we're going to remain cautious until we get a bit better perspective on when we see demand starting to return. So it is a fluid area. But many of the things that we've laid out of opportunities around how we're transforming our company, things we're doing to improve our supply chain, things we're doing to improve our productivity across the company throughout -- through the organizational announcements we made at the beginning of the year, those will continue to be there. But in terms of like structural actions that we're teeing up, I think it's just way too early for us to be commenting on those types of actions.

Fair enough. And then, I guess, maybe just closing the loop on this discussion. You guys talked about 2Q decremental margins of 30% to 40%. I guess, as you kind of think about the rest of the year, is it your expectation that decremental margins are going to improve as we progress through the year?

Yes. That's really going to depend some on the growth environment and how that develops in the coming months and quarters. As I've said before, we are actively planning for multiple scenarios, prepared to act depending no matter how it unfolds. Current focus is really -- right now, what I'm talking about is Q2, if there's an update on decremental margins and how we see them for Q3 and Q4, I'll share that later, but I think it's a little early for me to be sharing on any kind of direction we see on that. And the reason I say that is the decremental margins are going to primarily depend on where organic growth ultimately lands. And so if you think of it over time, in the third or fourth quarter, if you think of it by business, I think the single biggest driver is where we are with organic growth, whether we're closer to that 30% or closer to that 40% for decremental margins.

Okay. Fair enough. And so I'd be remiss -- kind of just switching gears, I'd be remiss to not ask about what the latest is on PFAS. So just if there's any development, that would be helpful. Any specific time lines or guidepost that we should be paying attention to? And I guess, within that context, like do you think just the current backdrop has changed any of the time lines just given that the -- I think the focus of our government system is really on a lot of other different things right now. Just curious, any thoughts around that.

Yes. Yes. Joe, thanks for asking that question. The -- as a reminder, we're proactively managing PFAS. And as we're doing that, we're guided by 3 principles: sound science, corporate responsibility and transparency. And so what are some of the developments that have been happening? So during the first quarter, we reached an agreement with Wolverine World Wide and that settlement was part of a reserve that we had taken in the fourth quarter of 2019. And we're continuing to work with the EPA and other state authorities to ensure we are fulfilling our ongoing commitments to compliance and environmental stewardship in our manufacturing operations. And we're making progress on commitments. So in -- we shared in a Congressional Committee testimony in September of last year that there were a number of actions we were committed to around research and sharing information on PFAS and we've been working on those. That included us launching a 3M clearinghouse on PFAS testing and the release of previously unavailable PFAS reference standards. And these actions, Joe, we see as an important step in advancing the collective scientific knowledge around PFAS. In regards to what COVID-19 is doing to this, we are continuing to work on this and the actions that we've put in place, albeit the pace is being impacted by social distancing and the slowdown in travel. So I can't say it changes a lot about how we're viewing the pending litigation other than we are seeing court dates and some of those milestones being delayed. So I think that's the biggest thing that we're seeing happen right now are some delays in court -- in some of the court dates that have been set up for litigation. Our next scheduled PFAS-related trial that I think is of -- that we consider a bellwether is in Michigan and that's currently set for October. And that is one that -- that's the latest date we have. It's possible that the COVID could change that time, but that's one of the important milestones we still have out there.

Super helpful. Appreciate you going through all that detail, Nick. Maybe if I could kind of switch it back into the businesses for a second. Consumer electronics is an area that it seems like it is starting to rebound. Is it fair to say that we're through all of the destocking that we've talked about in this market? And is it your sense also that any of the new product introductions that have been pushed out a little, call it like whether it's iPhone 12, like we'll start to see a pickup in demand maybe later this year?

Yes. Overall, our electronics business, just as a backdrop, it was up 2% in the first quarter. And in April -- we saw positive growth in April. Joe, we're seeing the most strength right now in places like semiconductor and factory automation. Consumer electronic devices that you were referencing there, I'd say that's mixed. Smartphone, just what we've seen through the first 4 months of the year, we're seeing smartphone demand still down. But we -- conversely, we're seeing growth in laptops and consumers as we believe consumers are purchasing those devices for work and school with stay at home and shelter in place. So that's been a little bit of a mix change we're seeing in the first few months of this year. As far as how we see that playing out into the second half, that second half is generally, in most years, stronger with the back-to-school time and holiday season. So we'll wait to see of how much of that strength is there for us in 2020. And the strength of the demand is also going to be dependent on these new product launches that you mentioned, Joe. And in particular, we're monitoring these 5G-enabled devices and launches of those and how much that will end up sparking consumer demand for these and what kind of consumer demand we're seeing through the pandemic for new devices. So we're prepared for that. We have multiple scenarios, but I'd say we're overall somewhat optimistic about electronics.

That's helpful color, Nick. Maybe switching gears again and just talking about portfolio for a second. You closed the sale of your drug delivery business just a couple of weeks ago. Maybe just talk a little bit about the rationale there and whether you're looking at additional portfolio pruning. And then on the flip side, how are you guys thinking about M&A in this environment?

Yes, Joe. We -- so overall, portfolio management, that's an ongoing process we're doing in 3M and it's one of our top strategic priorities. As we looked at our drug delivery business and our overall health care portfolio, we just did not see the drug delivery business as the best strategic fit within our health care portfolio. It's a project-based business operating in the pharmaceutical industry. And it had -- it really had limited connection and leverage of 3M's overall fundamental strengths. And that's a thought process we go through as we look at our portfolio and managing that portfolio. We continue to look at our portfolio through that lens, Joe, and it remains a focus for us. So we continue to look for opportunities in our portfolio for what's the best fit in our portfolio and what do we think would be better off in someone else's hands. On the acquisition side, we're still really focused on integrating Acelity. While we do have an active pipeline -- acquisition pipeline, we just currently don't anticipate any sizable acquisitions over the near term. And so that -- yes, so that's how we see it. On the divestiture front, we keep assessing that portfolio. And if we see opportunities that we can create greater value by not being in our portfolio, that becomes an opportunity for us to look and take action and divest of it.

Got it. That makes sense, Nick. I guess just -- since you mentioned Acelity, how's that business performing in this environment?

Yes. It's -- yes, thanks for asking. It's -- so 2 quarters in, it's meeting our revenue expectations that we had at the time we acquired it. From an EBITDA perspective, it's exceeding our expectations. Now that's 2 quarters in. As we're looking into the second and third quarter, I do, Joe, see elective procedures and the decline in elective procedures as having a negative impact. So, so far, good of what we're seeing. But I'm not going to be surprised to be seeing second quarter for sure, seeing Acelity's growth down from what we were projecting.

Got it. And then, Nick, we're going to be bumping up on time. But I did want to kind of ask one longer-term question, right, as it relates to some of the targets that you put out there at your Investor Day and the expected improvement, particularly on the operating margins, right? You guys were targeting 200 to 300 basis points by 2023. And last year, we took a step back. And this year, obviously, like nobody really could have anticipated the environment that we're in. So like as we think of kind of like the longer term, call it, 2023 targets, I mean, should we be rebasing these targets from last year's levels? Or how do you kind of think about the longer-term margin opportunity between now and 2023 for the company?

Yes, Joe, I still think many of the things that we shared that would be the drivers of that margin expansion as those continue to be the same factors, the same things that will be contributing to our ability to grow margin in the coming years. Now we were planning to be holding an investor event later this year. However, with COVID-19, we haven't set a date for that yet. When we do have that meeting, we, of course, Joe, will be providing more details about our longer-term outlook, including the margin expansion that you're talking about. But those drivers that are -- that we see expanding our margin in the coming years, our portfolio transformation, innovation, people and culture, those priorities, that's part of it. Transformation, we think, is going to be an important contributor to our growth and the expansion of our margin. And by transformation, that includes -- we've been deploying ERP systems to enable standardized business processes. We have new service models, new digital capabilities. We're realigning our businesses to align more closely to our customers. And we've optimized -- we're optimizing our supply chain footprint and including getting better leverage from data science and analytics. Those things are part of what we see as our margin expansion. And if it changes the 200 to 300 basis points of margin expansion, we'll share that at that investor event that we have planned.

Nick, that's very helpful. As always, it was great talking to you today. And hope -- thanks again for participating in the conference. And have a great rest of your week.

Great. Thanks a lot. Thanks for having me, Joe.