3M Company (MMM) Earnings Call Transcript & Summary

Good morning. Thanks for joining us. We're going to restart the industrials portion of the Wolfe Transports Industrial Conference with 3M. Very pleased to have Monish Patolawala, CFO of 3M, and Bruce Jermeland from Investor Relations. So gents, thanks for being here. It's a pleasure to host you this year. So folks, if you've got any questions, feel free to punch them into the text box or IM there, and I'll stop halfway through and see if there's any questions from the audience. So Bruce, I think do you want to make a quick statement and then we'll dive into Q&A.

Yes. Thanks, Nigel. Just want to remind everyone during today's discussion about our forward-looking statements. During the fireside chat today, we may make certain predictive statements that reflect our current views of 3M's future performance and financial results. These statements are based on certain assumptions and expectations for future events that are subject to risks and uncertainties. Item 1A of our most recent Form 10-K lists some of the most important risk factors that could cause the actual results to differ from our predictions. With that, Nigel, I'll turn it back to you.

Thanks, Bruce. Fantastic. So Monish, I hate to ask the obvious question, but it's -- you've been about a year in the job now as the CFO coming in from GE Healthcare. I'd just be really curious in terms of what you've achieved in the first year in terms of your priorities? And what do you think your priorities going forward from here?

Great. Listen, first, I would say, Nigel, thanks for having us. We're thrilled to be here. I'm here with Bruce, and we're going to try to tag team and answer most of the questions that we can. Yes, it's been a year or close to a year now, and I'm absolutely jazzed to be at 3M. It's a great company to work for and I'm having a blast. To answer specifically your questions, I would start with, Mike and I are completely aligned on the 4 priorities Mike laid out early 2020. Portfolio transformation, innovation and people and culture. So we are aligned on that. We are working towards it. To answer specifically on what we can do more, I just thought I'll start with a few philosophies that I believe in. Number one, I strongly believe that every company, how good they are can always do better with a continuous improvement mindset using daily management as a method to get better. Secondly, is using data and data analytics to not just visualize the outcome, but to use that as a root cause to find -- identify root cause early and then put in sustainable improvements. And third, whether you believe in lean or you believe in Six Sigma, it's all about measuring the x to get the y, which is if you control the inputs, you're going to get the output you want. So keeping that in mind, I've had a chance to do a few virtual gembas. So even though we are not back at the workplace, the team has done an amazing job of using technology as a way for me to go visit these factories virtually. And I would say there's a lot more opportunity we can do there. 3M is early in its journey on data and data analytics. And I think that's another place that we can continue to make improvement. And then the third piece of this, I would say, is as you think about data, data analytics, is figuring out root cause and sustainable improvements is another area that we can keep focusing on. So I believe all of these and this daily management, this better operating rigor will continue to help us. And you're going to see that in our growth, you're going to see it in operating margins and you're going to see it in strong cash flow. There are pockets of 3M that do this very well, and there are pockets of 3M that we can still do better. And that's what we are working on.

So making a more consistent performance across the portfolio?

Absolutely. Absolutely.

Okay. Great. Moving on to the businesses, and we had a very strong start of the year, 8% organic growth, actually quite consistent with what we saw amongst the lot of your peers. Anything that you saw during 1Q or going to 2Q that suggests that perhaps what we saw in 1Q was a bit of a pull forward or some action ahead of price increases, et cetera? Any kind of concerns that perhaps we're seeing a surge that maybe moderates as we go through the year?

Yes. To your point, we had a good start to the year. It was a strong growth across all geographies and all segments, which was 8% organic growth, as you mentioned. I would say, as we reflected on 1Q areas that came in stronger than we thought coming into the quarter ended up being a little bit around consumer electronics or tablets and TVs were very strong. We found in our roofing -- in the housing market, the roofing granules business, which is our business came in stronger. Home improvement, whether you think about indoor filtration, our filtrate brand filters or even our command strips or home improvement, came in strong. And then stationery and office supply, too, Nigel, came in stronger because of return to work. So those are the areas that we saw were stronger than what we thought. I think what we are focused and what we have -- we're talking -- thinking through is, how do these trends continue for the remaining part of the year? Our general belief is that our end markets are all moving in the right direction, but we still believe there's uncertainty, there's going to be evenness -- unevenness in the recovery. You're seeing some of it already through semiconductor, which everyone has talked about and what impact it has on auto industry. You're going to see the same on what happens with the adoption of vaccine, COVID, the government response, and what impact it's had on health care and elective procedures, including oral care procedures. We are also watching to see how stationery and office supply does, depending on the return to school season as well as return to workplace. And how that has its impact. So putting all that together, we felt prudent that at this moment in time, 1 quarter in, to hold to the guidance that we had given, which is a 3% to 6% organic growth guidance. But we are watching all these end markets, and that's what we are trying to monitor as we go continuously.

And of course, your guide implies a much flatter second half outlook at this point. So the message is it's too early to make a strong call still on stationery and office, oral care and elective procedures in health care?

Yes. It's too early right now. I think what you're going to see, Nigel, is as vaccines rollout or adoptions of vaccines happen, as you're seeing in the U.S., too, you are going to see elective procedures go up. So you saw elective procedures in the U.S., if my memory is right, exited somewhere in the mid-80s to mid-90s, depending on which source you go. And you're seeing that ramp-up in Q2. And the prediction is that by the end of Q4, you'll be back at 100% of pre-pandemic levels. Europe is in a slightly different end. It ended up -- I think first quarter came in close to mid-60s, 60% to 70%. There's a ramp to 70%, 75% in Q2 and then it builds in Q3 and Q4. But then you do have countries like India, which are unfortunate in a grip of a very difficult situation with COVID, and that's going to have an impact on electives. So I think we'll have to see how the world plays out when it comes to vaccine, the efficacy of vaccine as well as how COVID cases shape out in the world. And I think that's going to determine what happens with elective procedures. And I would say, similarly with oral care. So oral care in the first quarter, you've already seen and you saw the bounce back in our oral care business. But that is because a lot of the oral care procedures were back to pretty close to pre-pandemic levels, but there's still pockets that are up and down there. So that's why we still believe that this is going to be a recovery, but it's going to be an uneven recovery.

Yes. Nothing's normal about this recovery, that's for sure. So we wanted to dive into 2 more business units, end markets before we move on. Auto OEM, surprisingly strong in 1Q, given a lot of the supply chain challenges that those OEMs are having. What are we seeing in 2Q? It feels like it's a bit more pressure in 2Q. So curious if you're seeing some of that. And then PPE, there's a lot of discussion around that topic, especially with vaccine rollouts. What are you seeing in PPEs for the year?

Absolutely. So I'll start with auto OEM, and Bruce will tag team with me on this question, too. On auto OEM, we started the year assuming that bills will be up 14% organically. That was the IHS forecast, which is the ones we look at, too. I think the current forecast is down 200 basis points from there, so it's around 12%. The second quarter is a sequential drop of 1 million car builds from Q1 to Q2. So that's pressure, and then there's a recovery in Q3 and Q4. I think, Nigel, it will all depend on what recovery happens, how chip manufacturing plays itself out, how they get the chips and how the OEMs can make their cars works there. When we started the year, first quarter, mid-February, people said we should be able to be done by the end of 2021. There will be a full recovery. As you all have also reported, and we read the same, now they're saying the recovery could spill into 2022. So that's what we'll have to watch and see what happens with auto. On PP&E and health care and you've watched 3M for a long time yourself. I'll start with the first statement you yourself made, which is as vaccine rolls out, you are going to see a lower demand from the health care sector, I would say, but it also depends on a couple of other factors. It depends on the geography, it depends on what stage of COVID you are in and what recovery is, but it will also depend on government policy on stockpiling. So I think all of that is going to have an impact on where disposable respirator demand and volume is going to go. As far as we are concerned, we are focused on protecting our employees, protecting health care workers and general public. We ended -- we distributed nearly 2 billion disposable respirators in 2020. Half of it was in the United States. We exited with a capacity of 2.4 billion to 2.5 billion respirators. In the first quarter, we distributed 630 million respirators. I think the future, we'll see what happens. If there is no health care demand or there's lower health care demand, we will move our disposable respirators to industrial and consumer. Again, we'll see what happens with the recovery on the industrial side and consumer side. But for 3M, this is not new on how to handle an x factor. They have seen this before. And we'll act accordingly depending on how long-term demand turns out to be. But for 2021, we will have capacity of 2.4 billion to 2.5 billion respirators, and we'll see where demand goes. Bruce, anything else you would add on either of the two?

No. Just one comment I'd make on respirators. Q1, you saw that we had manufacturing to distribute about 630 million. So we are right on that run rate of around 2.5 billion. So as the year progresses, we'll adjust according to whatever the end market demand is.

So right now, your full beam's on production. Second half, potentially slightly below that level on a sequential basis, but too hard to tell where that goes?

You are right. We'll be ready to go, and we'll be ready to change as situations change, Nigel.

Right. Absolutely. Think about supply chains. And you were one of the companies, I think, early in March, to highlight some of the challenges with the storm and some resident supply and obviously, on the chip side. How is that tracking through second quarter? Have you seen any moderation and improvement in supply chain pressures?

Yes. Just as a reminder for everybody, what happened was I think all supply chains were under pressure in 2020 because of the pandemic. The pace of recovery, further put pressure. And then in February when the winter storm Uri happened, it just exasperated the situation. A lot of the chemical manufacturing in the United States, which is done in the Gulf area, was completely shut down for a few days, and that put tremendous pressure on the supply chain, especially on the chemical side. We are also seeing shortages on the logistics side, whether you take air shot -- whether you take air, ground or sea, there's tremendous tightness in the logistics market. And you're seeing most companies facing a lot of inflation, which is what we are seeing the same, too. I would say this is a fluid and dynamic situation. It's changing every day. We have a supply chain team that just does a phenomenal job managing day-to-day, has great relationship with our suppliers, who are also working very closely with us and our customers. So we're in close contact with both sides, customers and suppliers, making sure that we are minimizing the impact as much as we can from a disruption perspective as well as minimizing the impact from a cost perspective, but it's dynamic. My belief is that Q2 should be the toughest, and we should start seeing the world ease up in Q3 and Q4, but it's too early to tell right now.

But is it at a situation where it's impacting demand and your ability to satisfy demand? I mean, I know we're seeing lead times moving out. And -- but is that really materially impacting your ability to satisfy demand?

You're right. So lead times are moving up, Nigel, but you're seeing that in most industries. I don't think 3M is any different in that area. But we don't see that to have an impact to ultimately serve end market demand.

Okay. And maybe a couple more topics before we move on to some of the longer-term topics here. Inflation, you mentioned, Monish, and you've got $0.30 to $0.50 of year-over-year pressure for raw materials. Can you just remind us what you're assuming on the spot curves for a lot of your input cost? Are you assuming some moderation from here into the back half? And that's quite a wide range for the full year. I understand it'd be so. But what are some of the gating factors between the low end and the high end of that range?

Yes. So we take a number of factors into account, Nigel, when we gave you that range of 30 to 50 basis points. You're seeing -- us seeing inflation in 3 areas, raw material, labor when it comes to our outsourcing of hard goods, and then logistics cost, and you can pick the mode of transportation and seeing the pressure. The good news for us is that in 3M, from a raw material perspective, we don't have one commodity that is greater than a couple of hundred million that has an impact. There are 4 or 5 feedstocks that have impact that we track, which is polypropylene, ethylene, wood pulp, fluorspar. And all of those we monitor closely. We are seeing inflation in polypropylene, resins and chemicals. And that's what we are monitoring constantly to make sure this thing plays out. So to answer your question, between the high end of the range and the low end of the range, it depends on at what rate these curves start coming down. As I said, my belief is 2Q is the toughest when it comes to inflation, and hopefully, these curves start coming down in 3Q and 4Q, especially on the logistics side because with commercial aviation hopefully starting to pick up, you should start seeing some ease in the supply chain. So that's the factor as well as we are doing a lot of our own self-help, too, which is we are going and doing dual sourcing. We're working with suppliers to push out price increases as much as we can. And the success to do that will also have an impact on that range of 30 to 50 basis points. But again, this was at a point in time, we have made our estimate. We are constantly monitoring it as of right now. We still see that range. But as things evolve, we'll definitely keep you posted either on the positive or on the negative.

And just to be clear that impact, that's the gross impact, not the net of price impact, just to be perfectly clear on that. Just...

Correct, Nigel.

Touch on how your price actions are tracking? And are you going across the portfolio? I mean, I understand electronics is a tougher pricing environment, maybe more surgical. And given that you go through channels for most of your sales. Generally speaking, channels are very good pricing environments. Just wondering what's your confidence in offsetting that $0.30, $0.50.

Yes. So I'll start with just a reminder for people, in the first quarter, we had 70 basis points of price increase, but net price versus cost was a negative. In the second quarter, we had given you a guide of a negative of price versus raw. An impact of 75 to 125 basis points of pressure because inflation has come in much faster than price. 1 month into it, we are tracking to the high end of the range, which is 125 basis points of impact of net price versus raw. There's a lot of self-help we're doing. We raise prices across all segments and all geographies, so it's broad-based. Our -- we are working towards, and we have a plan. So we are working towards having a positive story in the second half, but it's too early to tell right now. As you know, we work through multiple end markets, it's not just through indirect channel only. And so to answer your question on channel versus where we see the end markets, I would tell you, we are -- as I said, we are going across all geographies and segments, but it's going to take a little bit of time because of the kind of the end markets we play in. You're seeing us increase price in channels. We are also working with our customers in various end markets that are expecting business to raise prices, and that's what we're working through. That's why we believe the second half, you will see a better price equation. But with all of that said, I just want to -- for everyone listening, and you know this, Nigel, you've followed 3M for a long time. 3M has historically had a good -- has done a good job of raising prices, 30 to 50 basis points a year, excluding electronics. We don't believe that equation to change in the long run, and part of it is the innovation and the value that we drive to our customers and the new products that we constantly introduce in the market.

Okay. Great. Moving on to portfolio -- and portfolio, I'm not sure how you -- comment, how you put it, but portfolio is certainly one of your priority, top of your -- top of mind issues. We've seen selected disposals over the last couple of years, drug delivery, gas and claim detection and then there's actually a lot more through 2017, 2018. Where do we stand right now on portfolio review? How active is it? And do you see scope for the pace of disposals and portfolio requirements to pick up from here?

Yes. So portfolio, I know many a time, we talk about portfolios, acquisitions and dispositions. But in general, as Mike said, portfolio is one of his priorities. I agree with Mike, it's one of the priorities. We think about portfolio broader than acquisition and disposition. It's all about making sure that the innovation that we bring, we can marry with market trends and customer requirements to make sure we continue to have market-leading products. We are constantly assessing ourselves on making sure, a, there's a market; b, we have the right to win. And when I mean right to win is, are these the markets where 3M's innovation can play, 3M's global presence can play, 3M's chemical science capabilities or material science capabilities can play. So we have the right to win. And then the third piece on portfolio is, are we really winning and how do we win? What's our go-to-market model? You saw Mike in early 2020, before my time, realign the business into 4 market-facing models. One was Industrial, then Transportation and Electronics, the Safety and Industrial, Transportation and Electronics, Health Care and Consumer. All of those were based taken into account is this should give us a better right to win, a better way to go-to-market. So that's how we look at can we win? Are we winning? And then, of course, are we winning? We compare ourselves versus a macro. We can compare ourselves versus competition, we compare ourselves. So we take all of that into account and we say, "What should we do? What are the actions we've got to take?" While we are doing that, we are always looking at saying, "Are we the right owner for the business? Can we add value to this business? Are we adding value to shareholders?" To the extent we don't believe we are, we will go ahead and divest. You have seen the company has not hesitated to divest. The last one, the big one done was the drug delivery business, which was done in Q2 of 2020. They've also done many other dispositions like the ballistics business, et cetera. So this is a factor that is taking into account. You would -- we will take into account not just the valuation of that business, but we also take into account a lot of other things like ease of separation, is there a better owner? Is there an IT that's related to it from a central perspective? Time and resources is going to take divestitures. We factor all of that in when we make a decision. And so far, based on everything I've heard and seen in 3M, there's nothing that has prevented us from doing the right thing from a divestiture perspective. I don't know if I answered your question, Nigel?

Certainly. Very, very comprehensively. You mentioned the ease of disposition is a factor. And I think we and others highlight the fact that 3M is a lot of -- how much in those technologies across the 4 different businesses. You have a very integrated manufacturing. In some cases, you have shared manufacturing centers. So it's not as easy as you might think to call apart that portfolio. Do we have a play in that card? Or is there some legitimate kind of reasons behind that?

Well, as I said, you have to take into account a lot of factors in most companies. These are not standalone entities out there. But you take into account factors all of these, but what I've seen so far is we haven't -- 3M has not done a disposition because of it cannot be separated. There's always a way to do it. It's a question of time and resources and the value. And if -- as I said before, if there's a better owner of this business and it can create more value to shareholders by somebody else owning it, I don't think the company would hesitate and I would not hesitate to move ahead.

Okay. Great. Innovation is something you also mentioned as well as part of your detailed answer. How do you rank today the innovation pipeline? And perhaps, Bruce, you can chime in here because given your history with the company. How would you rank the innovation coming through the R&D pipeline today versus maybe 5 or 10 years ago, especially in the context of the strategy to raise R&D spending over time towards 6%. How would you rank that innovation pipeline?

So I'll make Bruce answer the tough question, which is how does it read in 5 or 10 years ago. Listen, from my end, I look at -- one of the main metrics I first look at from innovation is what's the growth rate. Are we achieving the growth rate for all the money that we are spending? Of course, then the second is premium margins and the third is the ROIC. So that's my overarching metric. But then we look at areas that we believe that through the pandemic have given us an opportunity to grow. And some of them are personal safety, data centers or e-commerce or electronics, where you're seeing with semiconductor manufacturing, health care, biopharma. Are we spending the right amount of money? Are we allocating the right amount of resources in those areas that we believe are growth areas? I would also say when you think about innovation and what 3M has done over the last 100 years, the ability to solve customer problems to continue to get the price increases is another way of showing whether innovation is working or not. And then I would say the third piece is, when you think about all of these, you put it together and say, "Is it really showing up in the results?" So the company has announced what we call priority growth platforms. Think about them as areas of focus, it grew 7% in 2020 despite the overall company being negative, and it grew 10% in Q1. So some of them, again, auto electrification, biopharma and home filtration are all areas that were priority growth areas or focus areas that, Nigel, I would say, have grown more than the company average. I think long term, the R&D machine as long as we can invest in areas that are going to grow above macro and de-invest in areas that are starting to slow down or we feel have hit a point, I would say that's how we continue having our growth machine to perform. But Bruce, anything else you would add on just the second part of Nigel's question on versus a few years ago.

Yes. Nigel, if you think about our $1.9 billion roughly spent in R&D, about 85% of that is done in the businesses connecting our technologies relative to development to help solve customers' problems day in and day out. The other 15% really is the corporate big R Research. That's working on new platforms of the future. So -- which can be 3, 5, 10 years down the road. So the other thing to think about is 70% of our revenue is going into end markets that are driven by design and spec and/or are regulated. So product life cycles tend to very, very broadly across our portfolio, all the way from which gets a lot of attention on electronics, which historically has very short product life cycles, 18, 24 months, all the way to the other end of the spectrum in health care where you participate in regulated end markets and those products tend to have a very long product life cycle. So it varies across our portfolio. It's a consistent question. Certainly, investors ask, given the level of investment we have. But that 15% of -- the 15% of our spend really is in those priority growth platforms where we're trying to create platforms of the future. And our markets that are going through a lot of technology conversion, which in today's world, you immediately think about everything going on in the automotive industry, that's a great space for innovation for us to connect our material science capability into an industry that's going through a lot of change. So that's where we really get a lot of the traction from the investments, particularly in those longer-term growth platforms.

Great. We're getting close to the end of our discussion here, but I did want to touch on just some of the legacy liabilities, PFAS, air purification. Anything we should be watching out for between now and year-end in those areas?

Yes. So first, I would tell everybody, including Nigel, you know this, but we have pretty big good disclosures in all our SEC filings. Please make sure you're reading that as they come out so that you're fully updated. On PFAS, specifically, no real update from what we told you at earnings. Our next trial is scheduled for October when it comes to PFAS. On combat arms, you've seen the first verdict. So that 3 bell weathers that are currently -- that are going to be scheduled. The first one already got scheduled. We are disappointed, and we disagree with the verdict. We believe that we have grounds to appeal and the plaintiffs have not been able to show -- grounds to show that 3M was negligent. As I said, we plan to appeal it. And this is just the start of litigation, Nigel. So we'll defend it as we see fit. The second one is the trial is currently in progress. And the third one is scheduled for the next month. As we are preparing these trials, I said, we are prepared to defend ourselves. Do keep in mind, as I talked about from an earnings call perspective, too, we are seeing higher legal fees on PFAS and combat arms and some of these litigations. But again, we'll manage it as required.

Great. It's good update. And then just final -- finally on the balance sheet. You've been delevering the balance sheet post-facility, we're now in a pretty good position about 1.7x net debt-to-EBITDA, I think, is the number. What is the kind of strategy here? Do we continue to delever the balance sheet down towards 1x? Or do you think that we could see sort of more of a mix going forward? And then CapEx this year is looking to be $1.8 billion to $2 billion per the plan. I don't think you've ever spent that level on CapEx. I'm just curious what is your confidence in that range?

Yes. So I'll start with just deleveraging. We were at 2.2x at the beginning of last year. We are down 1.4x net debt-to-EBITDA leverage at the end of Q1 2021. The team has done an amazing job of continuing to strengthen the balance sheet. At 1.4x, I think we're in a good spot where it gives us a lot of strategic flexibility to either move down or up depending on what the environment of the situation is, and that's what we're going to keep working. What we can count on us, Nigel, is continue to drive cash and a strong balance sheet and a good capital structure is what we are focused on, and we'll keep doing that. To answer your question on CapEx, it's $1.8 billion to $2 billion is the current range. Historically, we have done, if my memory is right, between $1.6 billion to $1.7 billion. In 2020, we did $1.45 billion, but that was -- part of it was just through the pandemic, the company was making sure that we didn't overspend anything unless the demand exists -- started showing up. So you're seeing some of that spillover come into 2021. But more importantly, as we have said in our guide that we gave you, we are investing in growth, productivity and sustainability. For example, on each one of them, on growth, we are increasing capacity in our filtrate business, in our biopharma filtration business. And also in the fluids business, that supports data and data centers, so that's an example of where we are seeing end markets show up and we're putting money into increased capacity. On productivity, we are continuing to invest money in robotics and factory automation that you will see in margin because that helps us reduce the cost of products. And then on sustainability, we announced our new sustainability goals, mid-February. We said we would spend $1 billion over the next 20 years. It's CapEx plus OpEx. It's going to be front-end-loaded, so we can bend the curve. Approximately $100 million of that is being spent in 2021. So all of that put together, currently, we still see a range of $1.8 billion to $2 billion. And depending on how the environment plays out, Nigel, will go up or down because at the end of the day, we are in it for the long run. And we want to make sure we're putting in the right amount of CapEx to capture the growth as we see it coming in the longer term.

Great. Well, Thanks, Monish. Thanks, Bruce. We appreciate your time and being part of this conference. I look forward to catch up with you soon. But again, thank you very much.

Sounds good. Thanks, Nigel.

Nigel, thanks for having us.