3M Company (MMM) Earnings Call Transcript & Summary

Good morning, everybody, and thank you for joining us. Laurence Alexander with the Jefferies Industrial team. I think they almost need no introduction, but we have Mike Roman and Monish from 3M. And without any further ado, let me pass over to Mike for some initial comments and then we'll jump into some Q&A.

Well, thank you. Good morning, Laurence, and thank you for having me part of the conference today. I'll just start with a couple of brief remarks, then I'll turn it over to Monish to introduce himself as well. I would start here, and it's where we've been focused throughout the pandemic. We continue to fight this pandemic from every angle, working to focus on our employee safety and on protecting the safety of frontline health care workers and first responders. And I would say in this highly uncertain time and the challenges we all face in our businesses with the pandemic, we delivered strong operational execution in Q2. We delivered robust free cash flow, strengthened our balance sheet and at the same time continued to innovate and invest in the future. And as we discussed in our earnings call, as we come into third quarter, while there's a lot of economic uncertainty, we're seeing early sales trends improve across all of our businesses and geographies. I have been impressed with and have never seen the 3M value model look stronger. It's clear that it is positioning us well to lead through the pandemic, and we continue to take actions on a number of fronts, as I said, investing for the future, ensuring that we can lead through the crisis and out of the crisis as we move ahead. As I mentioned, I'm pleased to have Monish Patolawala join me as the new CFO. He's now 4 weeks-plus into the role. His experience in health care and multi-industrial background, especially with GE, along with the leadership he provided in driving operational transformation, makes him an ideal fit for 3M Company. And he's having an impact already in his first month here with 3M. Let me turn it to Monish for a few opening comments. Monish?

Thank you, Mike. Thanks. And Laurence, thanks for having me on this conference. It's great to be here. I am truly honored and humbled both at the same time to be leading, being the CFO of 3M, a company that I have respected for years as I've watched outside 3M, a company where my respect has gone even higher once I've come into 3M, has done a great job in handling the pandemic, very innovative, has good customer focus, a company that I believe has tremendous opportunity to drive value for shareholders through operational transformation, innovation and continuing to provide solution to the world while having strong cash flow through a strong capital allocation and disciplined policy. So I'm thrilled to be here. I look forward to today's discussion and future interactions as we go through my journey in 3M. And with that, Laurence, I'll turn it back to you, and we'll take it to questions and go in the direction you want.

Maybe let's just start with a discussion about operating leverage to the recovery. If you think about the traditional 3M playbook coupled with the cost actions you've taken, how much of a slingshot effect do you think you're going to have on a recovery in terms of outgrowing your end markets? Can you do better than the traditional 1.5x multiplier that you've talked about kind of across the cycle?

Yes. Laurence, I would say every slowdown in the economy, recession is a little different, but we traditionally have managed well in the middle of recessions and led out of them. And I think that's the 3M model. We adjust to what we see in our end markets. And you saw that from us in Q2. We took cost actions. We adjusted our production plans. We really got in line with the slowdown that we're seeing and also some of the increased demand that we're seeing as well. We responded well to both of those. That helps us manage through. That ability to react quickly in our operations and execute well serves us well in the middle of slowdowns in our end markets and in something like a pandemic, which is broadly impacting the markets that we serve. We also stay focused on customers. We stay -- prioritize our innovation model. We prioritize solving customers. I talked about 3 priorities in the middle of a pandemic like this is employee safety, fighting the pandemic, supporting first-line health care workers, first responders, but it's also staying in a position to deliver for our customers and make sure that we are serving them with our innovation, with our operations as they work through the challenges they face. That positions us well to lead back out of it. So we do see an opportunity to position ourselves even better with customers. That helps us lead out, get strong growth coming out of slowdowns. There are other dynamics as well. With our channel, the channel reacts to slowdowns. They adjust their inventory. They respond to any end market demand. And they do that on the way back up as well. So we see early days of recoveries. We do see some increased demand as channel inventories recover, as the entire value chain to the customer gears back up for increased demand. But it's really the heart of the 3M model that enables us to lead out. And then that execution and the focus that we take, the discipline that we show in the middle of it, that positions us well to perform when it comes to margins and cash flow and working capital. We're well positioned to continue that strong execution as markets recover.

And I think one thing that seems to be a common theme as people describe how this pandemic period has been different from normal recessions is how low inventories were coming into the downturn versus the trade war. There's been quite a lot of commentary around mix effects where higher mix products have had shocks that were different than in normal cycle and then the emphasis on sustainability coming out the other side. When you put those 3 together into a cocktail, how does that change the way 3M's divisions might come out on the other side, come out in 2021, 2022?

Well, Laurence, some of what you described, and I've said this about the pandemic in general. There were trends coming into the pandemic that got accelerated in the middle of the pandemic. And that's how we operate our businesses, some market trends, other dynamics. E-commerce is a great example. We've seen acceleration in the adoption of e-commerce in the middle of the pandemic. I think there's been a number of other areas along the lines the way you're talking. For us as a company, we were already on a trend with our transformation efforts to reduce cycle times, to reduce days of inventory outstanding, to improve service for our customers. And we were seeing that play out. As we started 2019, I was encouraged with early performance. Our first quarter results, you could see those benefits coming through. I highlighted that on our first quarter earnings call. I think the pandemic, even as we work through the disruption in the end markets, expectations from customers and I would say, shareholders as well, our expectation is we're going to continue that and take advantage of the pandemic to execute and be ready to come out with those kinds of trends helping us and getting stronger. And that we continue to make good progress on our transformation efforts to drive efficiency, drive performance, drive our responsiveness to customers. So I think those are trends that will play well. You talk about sustainability. You see that in investors, ESG broadly, but sustainability is a big focus. And it's a fundamental value for 3M. We've been a leader in sustainability. We've set big aspirations on how we can take that forward in our innovation, in our environmental stewardship, and we are really seeing that as a priority focus even in the middle of COVID. It's going to be an important part of the expectations our customers and shareholders and others have for us as we come out and lead out of COVID. So the trends you're talking about, I would say, if anything, they've gotten more focus, some of them accelerating and certainly continue to be top priorities for us.

And with respect to the transformation, the longer-term transformation project, to what extent have the 5-, 10-year targets been pulled forward? Or should we effectively come out next year and raise the longer-term target by the cost savings that you've done in 2020 and 2021?

Yes. And as we've gone through our transformation deployment and execution of our plans and strategies around transformation, we have talked about the benefits that we're going to see from it. And starting -- I'll go back to the investor conference, November of 2018. And I highlighted where we were going with transformation from there. We had just gone live in the U.S. with our new ERP and more broadly, the ecosystem around that, moving off of legacy systems into our new capabilities. And we were in the process and followed through on really working to take full advantage of that. And we saw that as something that would play through our performance going forward. We highlighted that we would see an opportunity to improve our COGS and improve our efficiency in our operating models, in our SG&A, which shows through and an impact on our margin moving ahead. Now we got hit with a slowdown in some big end markets in 2019 and then COVID in 2020, but we continue to make progress on those efforts. And as I said, you can see it start to come through in our Q1 results in areas like our COGS and more broadly our manufacturing and supply chain operations. We also highlighted, even coming out of 2019, restructuring plans that we had, which were really focused on accelerating the ability to take advantage of that transformation investment. And that's where we're at. We're working to take advantage of the deployments, the digitization more broadly of 3M and our business processes. And that we see as actions that will continue to drive improvements in our performance going forward. And we'll talk more about we get a better view on how volumes are going to play out and how recovery from the pandemic will emerge, but we really see our execution and our operating model, the value model of 3M getting stronger because of our ability to leverage that transformation. We'll talk more about examples and where that impacts our income statement, where that impacts our capital management. There's a number of places that you'll see that play through. It becomes now less about a project to deploy an ERP and more about consistent ongoing improvement in how 3M executes.

Can you sort of give some granularity about recent trends in the Chinese market, in particular Chinese markets, and then also automotive and electronics? And then I think also, I think elective health care has emerged as kind of -- it's almost a cyclical phenomena in this downturn. Can you give some sense of where we are at in the recovery and how you're thinking about the next few months?

Yes. Sure. And I think I'll start with where we began the year because it gives you kind of a frame. As we came into the year, we were talking about a return to growth for 3M in our enterprise performance, our company performance. And we highlighted what we saw in areas like China, automotive and electronics, 3 markets that's about 30% of our revenue, and they were in -- they saw declines in 2019. As we came into 2020, we saw sequential improvement coming in those markets, not great return to growth necessarily, including we thought Q1 would be softer, especially in automotive. Build rates still being negative in Q1. So that was kind of pre-COVID. We were looking at sequentially getting better, us as a company seeing growth from the improvements we were driving and the improvement sequentially in the end market. And as we came into COVID, you saw a lot of changes. And I'll start with China. China got hit in terms of the economy first. As the pandemic hit China, they shut down manufacturing operations. We saw industrial, electronics, broadly across our portfolio, we saw a slowdown in Q1. Now they were also earlier to reopen than the rest of the world, and we started to see improvements in second quarter. And we saw China growing. We saw organic -- positive organic local currency growth from China in Q2. When you walk around the world, Europe and then the U.S., you could see the slowdowns coming as the pandemic impacted those economies in March going into second quarter. And we saw slowdowns and down mid-teens as you went through Q2 in those end markets. And so now we're looking at it, how do the geographical end markets recover from the pandemic as they reopen? How does that play out? There's talk about a jagged swoosh kind of recovery because it's not necessarily going to be perfectly smooth across every end market. Your question about elective procedures in medical, health care in general, oral care and medical solutions for us, we see that. We certainly saw a slowdown, a steep decline in oral care as dental offices closed down in the middle of the pandemic. Those elective procedures are starting to come back. We haven't seen a big, material impact necessarily on our results in Q2 from that, but we're starting to see the procedures come back. And so we're expecting to see some recovery as we move forward. Automotive took a big decline in build rates in second quarter as everybody saw. Sequentially, maybe less bad as we get into third quarter. And so how does that play out? You start to see, as I said, some geographic starting to recover. You start to see some of the end markets seeing dynamics improving. As we come into July, we highlighted on our Q2 earnings call, we're seeing early days in July positive -- low single-digit but positive organic growth really benefiting from -- I see a broader-based improvement sequentially across those markets, across the market segments and the geographical markets alike.

And 3M's ESG profile is well known. So I guess the common question I get, maybe more so in Europe, but it's starting to get it more in the U.S. is what can you do to improve your profile from here?

Well, it is -- as I said earlier, sustainability is a core value for 3M. For decades, we've been a leader in environmental stewardship, how do we drive pollution prevention at the heart of what we do. We focus on aspirationally where we go to continue to drive that improvement. There's -- expectations are increasing for all companies. A manufacturer such as us, we have high expectations for ourselves. Our stakeholders expect us to continue to improve. So we think about it in 3 areas. We think about driving science for circular. How do we help create a more circular economy? How do we take material waste out of 3M operations? And that manufacturing, we've taken now 30% of our factories worldwide to zero landfill waste. Our goal is to take all of our factories to zero landfill waste. That's an effort we'll continue to move forward on. We are looking at how do we get circular in plastics. In areas like packaging and product, how do we think about that? Where do we provide leadership? We are -- it's part of what we can do in that science for circular. We have a science for climate platform, reducing greenhouse gas emissions, but reducing our footprint on the environment more broadly. And we've talked a lot about what we're focused on in environmental stewardship, really continuing to work forward on the PFAS, the legacy PFAS challenges that we faced from the businesses that we exited some time ago. And so that's been an area that we continue to expect to step forward as a manufacturer, as a global company. And then we have science for community, and we're going to focus on bringing science to supporting the community and their expectations of us. And also, I would say STEM education and how important that is to society and to companies like 3M as well. So there are multiple dimensions to where we see an ability to continue to move forward, provide leadership and set goals to improve as we go.

Can you tie that into your strategy with respect to ring fencing PFAS exposure across your chemistry applications? So not just the PFAS, but just the broader PFAS family, how you're going to change 3M strategy going forward?

We've been talking about how we are proactively managing PFAS, and that -- what does that mean? Really, for us, the principles that we bring to it, our corporate responsibility, sound science and transparency. And we are -- there are multiple dimensions to what we face with PFAS. There's where we historically manufactured and disposed of PFAS. And we've talked quite a bit about what we are doing to resolve that and work forward with the communities that we're part of. That includes not just resolving historic footprint of PFAS, but also to make sure we're stepping forward in environmental stewardship of our manufacturing operations, our chemical manufacturing operations, really reducing that footprint. It's part of our goal in and around PFAS is to reduce our impact on waste, as I talked about, but also water. And we are working on efforts. We've highlighted some of those that we've taken actions in areas like our Decatur plant to improve that. And we're working with the local communities and EPA, both state and federal level, to step forward and really lead forward from 3M operations. We also look at it as managing what we do in our innovation. And then part of our sustainability is ensuring that where we take our solutions for customers that we are driving a sustainability and environmental aspect of that. So PFAS has other dimensions, of course, as well. There's the litigation front and there's working at state and federal levels around regulatory aspects. We've been public in supporting the EPA's PFAS management plan and strategy, and we'll continue to support that. We highlighted at the last earnings call, I talked about a commitment that we've been following through related to that, providing a clearinghouse of information and research on test and measuring and better understanding PFAS. We're going to continue to work and be part of the path forward, working with governments, public-private as well as the regulatory agencies. So all of that is part of that proactive management. We'll talk more about it. We'll continue the transparency part. We are providing our updates on a regular basis. I'd steer investors and others to our 3M.com site. We continue to update on everything that we're doing to follow through on our commitments and update on information related to PFAS. So it's a very important priority for us to lead forward on.

And there wouldn't be a Jefferies conference without a question on record low interest rates and how negative or 0 interest rates might affect your M&A criteria. How do you look at the balance sheet? And how do you look at sort of the temptations or incentives to do something more aggressively with the balance sheet if it's, for example, in Europe where you can borrow at cheaper rates, if it's a more sustainable investment? So how is that affecting your thinking?

Well, Laurence, maybe I'll start with just kind of a view of the M&A strategy, where we stand in that as a company. And then I'll turn it over to Monish to talk a little more about how we think about that relative to capital allocation of the balance sheet. So I start here, acquisitions are an important way to complement what we do with organic growth. When we think of our portfolio strategy, first priority for our capital allocation, first priority in portfolio is make sure we're allocating our resources to the opportunity that can drive organic growth. That's our first priority. And that includes innovation and capital as well. Then the next priority is looking for acquisitions that can complement what we do organically and really leverage the fundamental strength, synergies of 3M, when they're integrated together, that we end up with the 2 companies becoming greater than the sum of the parts. And a great example is Acelity, our largest acquisition to date. That is an example where we really identified a strategy that we could acquire, bring into 3M Company, integrate into our medical solutions business and drive really strong synergies from those fundamental strengths. So that's the way we look at acquisitions. We continue to look at more attractive markets for the long term and those kinds of businesses and assets that can leverage those fundamental strengths. And so we have an active pipeline. We were pretty clear at the beginning of the year with Acelity coming in, that's our first priority. And it continues to be as we go through the year, successfully integrating that, really taking advantage of the improving elective procedures and moving forward successfully with Acelity. At the same time, while we're active, we were looking at taking our net debt to EBITDA back down. We flexed up to make the Acelity acquisition. We ended the year mid-2s in net debt to EBITDA. We laid out a plan where you shouldn't expect another large acquisition even before COVID in 2020 as we work to delever back down to more in line with 2 by the end of the year. Now COVID and what happens with the end markets kind of changes the progression on that, but we delivered strong cash flow again in the second quarter. So we continue to strengthen the balance sheet. So that's an important part of the strategy to support acquisitions in the future, to support a strong enterprise and that 3M value model. So maybe I'll turn it to Monish if he has anything to add about how we have been talking about capital allocation.

Sure. Thanks, Mike. And I would reiterate everything Mike said. We have said this multiple times. First priority is investing organically. So whether it's R&D, investing in the right commercialization for growth. Second priority is dividend. It's been a hallmark of 3M, and that remains a big important priority. And then our third is M&A and then followed by that is share repurchase. Mike already talked a lot about M&A. And as Mike said, right now, we don't intend to do anything big. Our job is to make sure Acelity is well integrated. We are happy with the progress we've made. We're glad we made the acquisition. Even with all the issues with the pandemic, the business has performed well. So we are happy with that. I would also say, this is a long game. So interest rates right now are not the things we take into account to do an acquisition or not do an acquisition because it's all about the long. And then the other piece is a priority that Mike had laid out with Nick in the first quarter and before that, too, was the portfolio management. So we've been active, on one side is the acquisition, on the other side is the divestiture. You have seen we have done 2 dispositions this year. We are constantly looking at which ones add the greatest value to our shareholders. And when we decide that it isn't, we'll be ready to take action, which we've done in the 2 divestitures we've done this year.

And then judging from the questions we've had sent in, I think the most popular question is a version of, are 2 billion masks enough? How much -- if we think out 4, 5 years, where do you see this going? And what kind of operating leverage should we expect for every extra 100 million masks, for every 500 million masks, how should we think about where this can go?

Well, it's a lot to unpack. It's one business, but it's a lot to unpack because of the leadership that we've really stepped into and I think really the, I would say, health care workers and others that look to us to provide. We have really stepped up our production in 2020 in response to COVID. We stepped up early because our strategy has been to have idle capacity ready for situations like a pandemic. We learned coming out of SARS that we are a leader in this space. We needed to be ready to respond, and we were. And so we brought that capacity online. We added additional capacity. So we -- to give you kind of one benchmark, we delivered in the United States from our U.S. production around 25 million N95 respirators to health care workers as we shifted everything to health care workers as we got into the middle of March. In June, we delivered over 110 million N95 respirators to health care workers in the United States. So you can see how quickly we've brought additional production and even brought in product from overseas. And part of that is a good public-private partnership with FEMA. It's us ramping up our capacity. And with all that said, our production -- the production of the entire industry can't meet the demand today. So we've got demand outstripping our capacity. As we go into the rest of the year, we will add additional capacity, some of that -- a majority of that in the U.S. from a partnership with the Department of Defense. They're funding additional capacity to help in the near term with the demands in the middle of COVID, also to be ready for building stockpiles for the next pandemic and to be ready for anything that might come down the road. There's still a lot of uncertainty in how this pandemic plays out. But you see governments, I think you see federal, state, local governments around the world really making the decision to step in and build inventory, not to be caught without inventory or not sufficient inventory anyway for something like this global pandemic. Health care providers also are looking to add inventory. So there'll be a -- even once we get through the demand of the use needed in the middle of the pandemic, we will see additional demand from building some of that stockpiling and inventory for the longer term. How long this plays out, we have a lot of different scenarios that we consider around this. There'll be some things that are fundamentally different. You're seeing dentists, for example, using N95 respirators for the first time. Will that be a new protocol that carries on longer term? That could be a market that now emerges and is a new market to sustain higher demand. How will consumers act as we go forward? Are they going to continue -- in some areas where they haven't historically used masks or respirators, will they demand it? So there are some things that are a little hard to tell today. What's clear is there's immediate demand that we are still trying to catch up to, and we'll do more as we go through the year. We've got partnership and investments with governments, including the DoD, as I highlighted, to help support that, to make it really make sense for us to continue to add. And then you've got this longer-term plan and strategy to add inventory, not just in the United States, but globally. So we'll be serving increased demand from historical levels for some time. And how long and how the demand curve plays out will really depend on the pandemic and how that progresses.

And I guess they're about to give us the hook, but just very quickly then is the -- are governments talking about having months or years of inventory when the dust settles? What's the rhetoric?

Well, I think it depends on the government. And they have strategies. And I talk a lot about respirators. That's our focus. But it's broader PPE is one of the categories that's interesting. And there's a couple of different strategies that are really being looked at and not just looked at but invested in. One is inventory, physical inventory. That's a way to have the capacity. The other is to build additional manufacturing capacity. We've been a beneficiary of that strategy with our partnerships, as I highlighted. There's also a discussion of you bring more domestic production in broader PPE categories in a market like the U.S. But it's not just the U.S. thinking about that. Other countries are thinking about that as well. And we work with other countries in helping to support that. So I think there is definitely increased capacity, whether it's additional manufacturing capacity or inventory that we'll be able to respond to a pandemic. So the idea is to position. So it means if you have additional manufacturing capacity, you can have less inventory because you can bring on scale. So there's different strategies that are being invested in, and I would say, investigated and invested in as we go.

Okay. Great. I think that's a good place to wrap up. And thank you very much for doing this today. And we managed to beat the grim reaper of the black screen of being carried away. So thank you very much.

All right. Thank you, Laurence. Have a great day.

Thanks for having us.