3M Company (MMM) Earnings Call Transcript & Summary

Good morning and welcome to day 3 of the Morgan Stanley Laguna Conference. I'm Josh Pokrzywinski, the firm's multi-industry analyst. With me this morning is the team from 3M, including CEO, Mike Roman; and CFO -- new CFO, Monish Patolawala. Before I get started, I need to read a brief disclaimer however. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Gentlemen, appreciate the time to join this morning. Always good to see you. Obviously, would rather be in person with the sun, sand and surf in Laguna but we'll take it. Mike, if you wouldn't mind, just kicking us off here with any kind of opening observations, that would be great. And then we can dive in.

Yes. Well, good morning, Josh, and it is great to be with you today, too. We continue to fight the pandemic from every angle to ensure the safety of our employees, our health care workers, first responders and the public, and that's really the priority focus that we take through COVID-19. It's a highly uncertain environment. And in this environment, we delivered strong operational execution, including robust cash flow, and we've strengthened our capital structure in Q2. We also continue to innovate for our customers and invest in the future for growth and productivity. So global uncertainty remained high due to the pandemic. And as we reported earlier, this week, sales through the first 2 months of Q3 were $5.5 billion, up 4% year-on-year. So good progress as we come into Q3 with that uncertain economic outlook behind it. Through 2 months, we've seen improvements in sales trends across businesses, led by Health Care and Consumer; and geographies, led by the U.S. and China. As always, September is an important month in Q3, and as we reported, we continue -- we currently estimate Q3 sales to be in the range of $8.2 billion to $8.3 billion. So given that uncertainty, we plan to continue our monthly reporting of sales information throughout the end of the year and provide some transparency on our ongoing business performance. In the middle of a pandemic, it's never been more clear, our value model is strong. And we continue to invest in both growth and productivity to lead through this crisis and emerge even stronger. Monish Patolawala, our new CFO, joins me to participate in today's discussions. We are pleased to have him as part of the 3M team, and he's already making a big impact. With that, Josh, I'll turn it back to you, and we're happy to take your questions.

Excellent. I appreciate those comments, Mike. And we will dive right into it.

I guess just maybe a finer point to make sure everyone's clear on the third quarter outlook. I think implied within that September is a bit of a deceleration. There's some selling day differences, what you guys have been highlighting around. It does look like there's a little bit of a step back implied. Is that kind of consistent with the way September started? Or is there something going on in the channel that we should be aware of that you guys are more closely following?

Well, I would say, as I highlighted a couple of times in my opening remarks, there's still significant global economic uncertainty given the pandemic. And so I would say it's prudent for us to remain cautious given that environment. It's not your typical year. September is always an important month in Q3. Our range, $8.2 billion to $8.3 billion, that's 3% to 4% year-on-year growth. It's reasonable, we think, given the uncertain environment. And September will be critical. And so I would say that's kind of the background of where we're looking at it. We did see some channel restocking in July and August and I would say particularly and maybe specifically in Health Care and Consumer as elective procedures returned and consumer retail trends improved. Beyond that, I would say we see our customers generally remaining cautious, given that economic uncertainty. So we're focused on driving the best performance and serving our customers, capturing share, continuing to invest in the opportunities that are emerging here and lead through this pandemic.

Excellent. And then, I guess, just sticking with the end markets. Some of the more topical end markets are certainly the ones that can move around a bit: auto, industrial, electronics, health care. Any prevailing momentum that's moving in one direction or another? You mentioned on the health care side elective procedures picking up. I think we've heard that from some other folks, presumably a backlog of activity that needs to happen there. Kind of steady improvements across the board in some of those other markets I mentioned?

Well, I would say -- you mentioned auto at first. In auto, we're seeing a sequential improvement, coming off negative 45% build rates in Q2. IHS came out earlier this week. We're looking for a 5% year-on-year decline in Q3 of car and light truck build. So that's up sequentially. Industrial, the pandemic has caused a global slowdown in manufacturing activity, and we saw that really hit hard in the second quarter. We declined 6% in Q2. Personal safety, part of that industrial portfolio, was up double digits based on that incredible unprecedented demand in respirators, and that offset the balance of the rest of the portfolio. As you said, elective procedures in health care are improving. And we're seeing that starting -- that hit us hard in Q2 on the negative side, and we're starting to see that have a positive impact and a positive outlook as we go through Q2. We saw a significant downturn in oral care and dental practices demand in Q2, down nearly 60% year-on-year, and that's now starting to improve as we come into Q3. And if -- electronics, maybe to put that in perspective. Just as a reminder, when you look at 3M, our business in electronics is about $3.5 billion in annual revenue, with about $2 billion of that going into consumer electronic devices, smartphones, tablets, PCs, TVs; and the other $1.5 billion primarily in semiconductor manufacturing, factory automation, data center end markets, all areas that we've highlighted as growth. Our business was down 1% in Q2 based on strong growth in semiconductor, factory automation and data centers, and we see that continuing to offset some softness in consumer as we come into Q3. So a few of the dynamics that we're seeing as we come into Q3.

Excellent. And then, you mentioned inventory a little bit, some selective restocking there. I think you said Health Care and Consumer being the biggest areas. Those, I think, conceptually, are pretty clear. How would you characterize inventories otherwise across kind of your customers as best you can tell? And do you think there's a replenishment that happens more broadly before year-end?

Well, every downturn and dynamic like this is different. And our channel -- if you look beyond 3M and you look at inventory in the channel and the end-use customers, they're managing through an uncertain environment. We did see some snapback in Q3 -- early in Q3 from the increased elective procedures in health care and in oral care in general. Across industrial, we came into the year balanced. I think our customers were conservative and careful as they went through Q2. They continue to be cautious in the face of this uncertainty. We don't see a snapback, a broader, across industrial markets. Electronics, as you know, the second half of the year is when the demand really ramps up. This is -- so we'll see some changes in the channel as they get better visibility of that demand. So we don't see the inventory in the channel reacting ahead of that. So I would say the area of note is really in health care, medical solutions and oral care for us.

Got it. That's helpful. And then, I guess, just as that pertains to the margin outcome, I think a lot of the cost initiatives that 3M enacted this year, given that you had the big program of more structural actions in 2019, were a bit more tuned around managing the near term. As demand is -- it seems like it's come back a little bit better than you would have expected in 2Q. How should we think about the interplay with some of those temporary cost savings, the timing and how that phases in, either through the quarter or how you're thinking of that more broadly?

Well, Josh, I'll turn this one to Monish.

Sure. Thanks, Mike. Josh, as Mike mentioned before, September is a big month for us. Indeed, we are encouraged by the end market signs. We are still continuing tremendous cost and cash control through this uncertainty. It's very uncertain out there, so we are following the same kind of rigor that was put in prior to me coming in year 2. We're continuing that. Our goal is to, of course, save as much cost as we can while also driving a lot of cash flow to strengthen our capital structure. So we are focusing a lot on inventory, inventory control at our end, too. And then on the other side, which you said, what should we think about the future, I think we are investing where we feel appropriate. So you will see us investing in growth and productivity in the sectors that we feel comfortable, that are starting to make progress. Mike already talked about some of those. And that's why you would see us continuing to invest, not just for the current quarter but invest for making sure that we are ready as the volume comes back up in 2021, that we are there to play. So that's how I would look at it.

Got it. And I guess somewhat related to that, Monish, you and I had a couple of conversations now since you joined. A lot of excitement that I can detect in your voice around the margin and cash opportunities, I think, over time, starting from a good place obviously already at 3M. How should we think about as some of those broader productivity actions take hold? I think every organization that we've talked to over the past 3 days has had some unintended benefits from things like lower travel. You mentioned yourself doing some virtual plant tours. Do you think that kind of core productivity into next year can offset as some of those normal course of business items start hitting the P&L? Is that an attainable goal in your mind?

So Josh, it's very early to discuss 2021 as we are working through that. Our goal, of course, is always controlling costs. What you should expect from us is grow at or above macro, that we give you consistent margin expansion each year and then give you strong free cash flow. The question that will come out is how much do we reinvest back for growth or continued growth in '21 and '22. And that's what we'll keep working through over the next few months as we get into 2021. But that's the way I look at it. Will there be cost that comes back in? Yes. But the team has also taken some good actions along the way in 2019 and in 2020 that should help us, too. So as I said, think about us as grow at or above macro, consistent margin expansion and good strong free cash flow. And then, in the spirit of continuous improvement, my view is, every business always has a chance to do more on cost and cash, and that's what we'll do.

Understood. Maybe kind of a tag-team question for both of you, Mike and Monish. Just on that growth snapback that you talked about. I think the 1.5x IP through-the-cycle multiplier, that has been kind of the target for 3M. Any reason why -- in what is a pretty weird year, I think we can all admit, why that would look different at the outset of recovery, either better or worse, things that we should keep in mind? I guess respirator production could be one thing that someone could say, "Okay, that's a tough comp," or maybe higher auto production, just given how big of a hit we took this year. It could be something on the other side. Just kind of weighing that, is there any reason to believe, high level, that you would deviate from that multiplier?

Well, as Monish said, Josh, that our strategy, our goals are to grow above macro, deliver steady margin improvements and strong cash flow, and we expect to do that through the business cycle. Every downturn and recovery is different, and the dynamic and the uncertainty here, it's going to play out across the world markets. This one is unlike past recessions. And so as we continue to manage through COVID and drive those priorities I talked about, we're staying focused on customers in virtually every end market and really driving that idea that we can bring our innovation to our customers, we can drive growth above macro and we can deliver on that strong performance that we've been talking about. So I think there's -- it's going to depend on how the markets recover, where that growth comes from. We do expect to be able to continue to deliver that kind of performance as we emerge from the slowdowns, as markets recover, as we move into the rest of this year.

Excellent. That's helpful. And then, Mike, you mentioned innovation. I guess, Monish, you did as well. Just taking a step back. Obviously, that's a part of the 3M culture, deeply ingrained, some of the higher R&D that we see across our coverage universe. Where should we think about the best returns on that R&D? Obviously, margins tell part of the story, it's a bit of an indicator, but some categories just naturally have higher margins or maybe less R&D intensity. So where should people think about the innovation really being focused? Where do you get the best returns on that? And then maybe separately, Monish, if you want to follow up. Just coming in with fresh eyes, are there measures of that productivity -- that R&D productivity that you think 3M might be able to benefit from?

Well, Josh, maybe I'll start with capital allocation. As we've talked many times, our first priority for our capital is to invest in our businesses, including R&D and CapEx, to really drive that growth, that performance through our portfolio broadly. And when we're driving that innovation, that is what delivers that strong margin performance and that strong return on invested capital and that strong cash flow. That's behind that. And it's also important to delivering growth and growth above macro. To really grow above macro consistently, we have to do 2 things well. We have to deliver on innovation. We have to innovate and create new opportunities for 3M business, penetration, share growth in the marketplace. And then we have to do that in markets and with customers that really we can drive value with that innovation. So it's got to be attractive markets, markets that are growing. And so that's how we look at that grow-above-macro model and that grow-above-macro model that leads to that strong cash flow. So as we go through COVID, there are new opportunities emerging. We continue in the way we look at our portfolio to really prioritize where we make that capital investment in our businesses, in those most attractive areas where we can leverage our fundamental strengths, our technologies to get the biggest impact from our innovation. So it's really that kind of focus that will enable us to drive that growth above macro.

Any particular areas of focus that you'd want to leave people with?

Well, we see areas in the middle of COVID that we're investing in. Clearly, PPE has been an area where the demand continues to outpace our ability to deliver to it. There's innovation going on there. We have reacted in fighting the pandemic to quickly adapt our cleaning and disinfectant product lines and bring new products to market. We see strong demand in home improvement. There are some trends that really have emerged and accelerated under COVID. You see a digital-first world, and that is driving demand for electronics. It's really driving that -- some of that dynamic behind semiconductor fabrication, data centers. These are areas that we have highlighted as growth opportunities for us, and they're areas that we really see as accelerating trends under COVID. That home improvement model, people are staying home more, they're investing in their homes right now. We see our innovation -- and this has been an area where we've been, I think, an innovation leader, in home improvement areas. And so it's a -- those are priority opportunities for us. And even when you look at the elective procedures coming back in health care, there's some new dynamics. Dental offices, in order to open up faster, they have to bring new solutions in PPE and also oral care innovation. So there's opportunities we see as we go through COVID, and we think those are some attractive places for our innovation.

Got it. And don't I know, I'm getting hit with a $20 PPE charge for my dentist appointment next week, right? So you're welcome.

Yes. Thank you, Josh.