3M Company (MMM) Earnings Call Transcript & Summary

All right. Good morning, and thank you once again to everyone for joining us here at the Ninth Annual Crédit Suisse Industrials Conference. My name is John Walsh, and I am the multi-industrial analyst. We're very excited here on day 2 to have with us the team from 3M. We have Mike Roman, 3M CEO; Monish Patolawala, CFO; and also Bruce Jermeland from Investor Relations. Bruce is going to make a comment before kicking it over to Mike, and then we will start with the Q&A. So with that, I'll hand it over to Bruce. Bruce, I think you're just on mute.

Sorry about that. Thanks, John. It's great to be here with you again this year today, and we hope that everyone is doing well and continues to be well. Before Mike and Monish begin talking with John, we'd like to take a moment to remind every one of our forward-looking statements. During today's fireside chat, we'll make certain predictive statements that reflect our current views about 3M's future performance and financial results. These statements are based on certain assumptions and expectations of 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 actual results to differ from our predictions. With that, John, I'll turn it back over to you, and we can kick it off.

Great. Mike, the floor is yours.

Well, thank you, John, and good morning. It's good to be with you today. I thought I'd open with a few remarks on what we're seeing. Year-to-date through the third quarter, we've delivered broad-based organic growth across all businesses and geographic areas with good margins and strong cash flow. I would say overall end market demand remains strong. And longer term, we're well positioned for growth. However, in the near term, we all face significant challenges in the global supply chains. In this continuing highly dynamic environment, our teams continue to remain focused on serving our customers while navigating challenges with raw materials, labor, logistics, the challenges we all face. COVID continues to evolve and put tremendous strain on global health care providers, particularly nurses, doctors, impacting elective health care procedures. And the semiconductor shortage continues to impact our end market demand, most visibly for us in electronics and automotive. I would say the well-known challenges related to raw materials, labor, logistics availability are causing significant inefficiencies for us, productivity headwinds and increased costs in our factories. And we're experiencing more fluid demand planning, shorter production runs and more frequent production changeovers in order to keep our factories running. The combination of strong demand in those end markets, along with these supply chain challenges, is also contributing to broad-based inflation that everyone is seeing. And while we're taking multiple actions to help offset inflationary pressures, including price increases and dual sourcing and improving our factory yields, we still have more work to do. Ultimately, the duration of these supply chain challenges is difficult to predict. We remain focused in our efforts on serving our customers, managing our backlogs and making good on our commitments, delivering the high-quality products that are the hallmark of 3M. Looking specifically at Q4. Based on what we see 2 months in, we now expect organic growth to be in the bottom half of our implied Q4 range, which was flat to minus 2%. Our teams continue to respond well, and we're focused on closing the year strong, working hard, adapting to this challenging environment to deliver for our customers and shareholders. And John, before I hand it back to you, I'd like to mention that we are hosting a virtual Investor Day on the morning of February 14 where we will provide near-term strategic update along with our 2022 outlook. So please stay tuned for further details. With that, let me turn it back to you and -- to take questions for both Monish and myself.

Great. Thank you and appreciate that update. Maybe we first can unpack that organic growth and what you're seeing in Q4. Do you have any color to provide around the segments and maybe which are coming in a little bit better or if there's kind of all coming in a little bit towards the lower end of the range there?

Yes. John, I would say -- as I mentioned, we still see strong end market demand, and there are some impacts out there. I highlighted a couple of those. Health care elective procedures still remain below 2019 levels, really impacted by COVID, ongoing impact there, playing out as we go through the quarter. Semiconductors, we start to see some signs of things getting a little better or at least not as worse, but it's below what we expected as we came into the second half of the year. So that's still -- we're seeing that in the automotive build rates and the electronics demand. So that's still playing through. And then I would say, for us, it's more of the challenges we're facing and delivering on the demand that we have for customers. We see -- still see broad-based end market demand. It's on our ability to navigate those supply chain challenges and deliver for those customers.

Great. And maybe just one on automotive. And obviously, you are a global supplier into automotive, not just supplying one company. But yesterday at the conference, for example, GM had talked about being able to get a little bit more semi chips and be able to kind of talk a little bit more positively about their production ramp. Just curious, given where you sit in the industry, what are you seeing? And obviously, we do look at 3M's growth relative to those production rates. And how would you think that, that kind of trends going forward?

Yes. John, I would start with -- we're well positioned with the automotive opportunity. And it's both electric vehicles and where that growth will drive opportunity for 3M. And it's also automotive more broadly as it recovers from some of the challenges, the semiconductor shortage. And so we're -- we are focused on driving our innovation with OEMs around the world. And we're winning specifications. We see the opportunity to continue to outgrow the build rates. And that's been a hallmark of our automotive business, something that's been, I would say, further advantaged through the opportunities we see in electric vehicles and greater penetration of electronics even in the internal combustion engine platforms as well. So we're -- that opportunity and really what we've been focused on when we talk about the outlook near term has been the impact of semiconductors. And that is well, I think, well documented as we came into the second half, that build rates globally would be negative, and that this was really one of the strong drivers. We see signs that it's getting a little better, but it's still negative build rate -- outlook for negative build rates. And like I said, we're well positioned to outgrow those build rates as we go. But it's a -- now the focus is on how that recovery continues from here. And I don't have a view of how fast it will recover. We're hearing some of the same things from our OEMs that you cited related to GM. We're hearing the outlook is getting a little better. But it's still -- I would say, build rates are still negative year-over-year.

Great. And maybe touching on that theme of vehicle electrification. Clearly, big secular theme, 3M plays into that, both on, as you said, interior electrification, actual electrification of the drivetrain. Can you help us understand what the growth algorithm looks like, like either a dollar content per vehicle or something that we can use as we build out our models of what the opportunity looks like?

Yes. It's really an important area. We've talked a bit about this. It's one of our growth platforms, one of our strong high-growth platforms that we're investing in as we come through and out of the pandemic. It's an area that we've highlighted in our priority growth platforms to really enable where the industry is going. The innovation that's going on in automotive in general is a significant opportunity for us as a company. Look, we've been in automotive for more than 80 years. And we've driven innovation broadly in automobiles and light-duty trucks, really driving multiple different technologies, everything from assembly methods to acoustic solutions to electronic displays, even in the internal combustion engine kinds of platforms. There's an increasing penetration of electronics, and we bring some of our innovations from the electronics -- consumer electronics to what is becoming the next consumer device, the automobile. So those are part of the opportunity to accelerate on what we've built as an innovation platform in automotive over those 80 years. So the -- as you look forward, the electric vehicle itself is driving innovation in the battery and the powertrain. It's driving innovation in new materials and assembly methods. It's driving requirements around acoustic solutions, even greater need for acoustic solutions. So we're seeing multiple areas where we can innovate. And we have now -- we look at it as more than a $300 million revenue opportunity today, growing double digits as we go forward. It's a -- the market is growing like that and the opportunity for us as well. So that's kind of the starting point is that platform of innovation into automotive more broadly and now the acceleration in innovation that's coming from electrification and greater penetration of electronics.

Great. Maybe taking a step back and going back to a bigger picture question. We've seen a lot of announcements in the space around simplification, deconglomeratization. Mike, you've made portfolio optimization part of -- one of your pillars. How should we think about 3M in light of some of those announcements from other peers?

Yes. As you said, John, portfolio management is one of our top strategic priorities. It goes hand-in-hand with our innovation focus and driving greater innovation for our customers and really looking to do that where we can create the greatest value. And we start there with portfolio management. It's an active process and ongoing. It's not a strategic once-a-year kind of process. This is an ongoing process for us, actively managing our portfolio, looking at how do we leverage the strengths of 3M to create the greatest value for our customers and returns for our shareholders and really advance our position in markets. And it starts with organic opportunities. How do we prioritize where we make the investments? And we've been talking about some areas that we've accelerated investments as we came through the pandemic. And they represent this portfolio, this active management, looking at what are the most attractive markets, leveraging our technologies, our manufacturing capabilities, our global capabilities and how do we really make sure we're investing in those areas to really position ourselves for growth, growth that outperforms at or above the macro economies that we're part of. We use portfolio management in that strategy to look at where complementary M&A can help us create greater value. And you saw that with the most recent acquisition, Acelity, bringing a leader in advanced wound care, combining it with our position's organic development of that market and really accelerating our position in the market, leveraging the fundamental strengths of 3M, bringing together 2 companies that when they're combined are greater than the sum of the parts. And that's the view of portfolio management on M&A. And we have an active pipeline looking at attractive markets that we can leverage 3M fundamental strengths when we integrate it as part of our company. And finally, we're looking at where we are not the best owner for creating value, value for customers or shareholders. And we'll take action. We've done that with our drug delivery divestiture, the majority of our drug delivery business being divested. We've done that in other actions and continue to be very focused on that. So this is an active process, an ongoing process looking in those 3 areas.

Great. And then maybe a segue. If we look at your balance sheet post-Acelity, right, you've delevered. Maybe can you outline some of your priorities between kind of the M&A pipeline, share repurchase just kind of given what's been happening with global markets? Anything there?

Yes. It's a -- and we followed a plan that we even talked about as we brought Acelity and integrated into the company that we were going to take our leverage back down below 2, and we were going to position ourselves for long-term value creation. And really, it comes back to our priorities for capital allocation. And as we've been talking, our first priority is investing organically in R&D, in CapEx to deliver on the opportunity we have to drive growth with our capabilities. The second is priority for us is dividend. It's been a high priority for us. We are a long-term dividend payer. We've been increasing for more than 60 years, our dividend. So that's -- continues to be a high priority. And then M&A is where we see -- just back to our portfolio discussion, this is where we can create additional value. We can leverage our strengths and opportunities to acquire businesses in attractive markets. That's our next priority. And then we'll look at other opportunities, including share repurchases as part of our capital allocation. But that's how we think about it. That's how we look at it. And where we are today with our leverage gives us a good position to be able to manage that capital allocation strategy and those priorities.

Great. And maybe shifting the conversation to the margin. You provided the update on how you're seeing the sales outlook for Q4. I know on the call or the Q3 call, there were some headwinds to the margin in Q4, be it 1 less day, some legal costs that were burdened in the segment. Can you provide any update on how we think about the leverage in Q4 in light of [indiscernible]

I'll just start with a couple of things that all of them impact margin. One is, as Mike mentioned, and we have said it multiple times, volume is the item that gives us the biggest leverage. And Mike just told you where we are going to be for the quarter, so that definitely has an impact on the margin. But again, it's got a month to go, so we're going to keep working that. If I take this to a few other points in that, we have talked about price, and inflation is definitely one of the items. You saw in the second quarter, we were at 0.14% of price increase. It moved up to 1.4% in the third quarter. And we're continuing to see that go through and increase as we go into the fourth quarter as the coordinated approach that we have taken to pricing starts going through. On inflation, we had given you a range of $0.85 to $0.90. It's pretty much in that range as of right now. But we are continuing to see supply chain shortages that are impacting supply chains, whether it's logistics cost, whether it is raw material inflation. You're getting pockets up and down. We are still continuing to target to get as close to neutral on a price raw inflation basis as much as we can in the fourth quarter. I think we'll have to wait until December closes itself out to figure out where inflation lands and how much price we were able to get. Mike mentioned already on the factory front, which is another impact that impacts leverage is, we are having shorter runs. We're having faster changeovers, a lot of quicker, more changeovers. We continue to have sometimes line downs when we have raw material shortages, but we are doing whatever it takes to make sure we're taking care of our customers. But that clearly puts a pressure on productivity in the factories. But again, as Mike mentioned, long term, all these things will work itself out. In the short term, we're working. And then the other piece was legal fees and investment in growth productivity and sustainability. So legal fees, as we had mentioned during the earnings, we are continuing to have those cases that are happening in the fourth quarter. We are spending the right amount of money as required from there. And then the last piece is investment growth in growth and productivity and sustainability. As we told you, we will not shy away from doing those investments. So we're continuing to make those investments in the fourth quarter because we see the end markets are strong. And I think we are getting ready for '22 and '23. And as these end markets come through, we're going to make sure we keep investing in that. So I would put all that together and say, just giving you more color to your question. And then back to your overall leverage question, the way I look at it always is long term, when all things being equal, you just start with my EBITDA and 3M is between 27% and 28%. So you start at that base and you move yourself up from there. But each year is so unique, right? If you look at 2021, there's nothing that's normal about 2021 and the leverage and the property sale we had last year and the inflation issues this year. But long term, all things being equal, start from there and move up, and volume gives us the best leverage. And that's what we keep pushing on is to grow at or above macro, which will give us a lot of leverage.

Great. And that's a segue kind of into the next question. As we think about leverage going forward, you've been very public with that 30% to 40% range. I understand there's a lot of uncertainty out there in the world, but you also have a nice restructuring tailwind that will start flowing through next year and beyond. I mean in light of that, how should we think about maybe where we fall within that range if we can get some normalization of supply chains?

Yes. And John, that's the whole thing is normalization, and it's normal, right? I think that's what we keep wrestling with. But I would start again with what I just said, my EBITDA is in the 27% to 28%. So you start from there. And then we move from there. To the extent that we can navigate and get better flow of raw material, to the extent that we should be able to continue to get the price, the restructuring benefit. But at the same time, there are always other things that are in play, which is investing in growth, productivity and sustainability. So I think it comes down to each year is quite unique. I think indirect costs that have just started in '21, you're going to see more of that in the next few years, depending on how the pandemic plays itself out. So I would start with 27% to 28% and move myself up from there. It depends on each year and depends on what volume and how the factories are running based on all the supply chain constraints we're seeing.

Great. And maybe just pivoting back to that portfolio question. One of the things, as I at least think about 3M as you truly are a material science company versus necessarily an OEM product company, and with that in mind, you still have been able to do some pruning as you talked about. Can you just talk about the ability to actually potentially do something larger and if that's something that you would consider?

John, I'd go back to the strategy that I described. And it's really actively managing our portfolio around the fundamental strengths where we are uniquely positioned and have the ability to differentiate value for customers and returns for shareholders. And that's going to guide us. It's going to guide us, as I said, where we invest and where we make acquisitions. It's going to guide us in how we think about the portfolio we have today versus the portfolio we will have a generation from now. And I think we've got a history as a company of shifting our portfolio to where we can uniquely drive that value. And that, increasingly, over the last decade has included divestitures as part of that process. And so that's all something that we focus on. And it's -- the big split-up of companies is the focus today. For us, it's really about back to fundamentally where do we create value. And that can be in small parts of our portfolio. And we've made a series of smaller divestitures, even some product exits. We've changed how we manage some of our portfolio. And we look at that more broadly across the -- really across the entire portfolio of businesses that we have. So I'm not going to predict where we are going to go, but that's what drives us. And it's a very clear focus for us about creating value into the future, and we'll continue to use that as the driver.

Okay. And then maybe shifting to some geographic commentary. We have had some management teams raise concern around the China macro. Would love to get your perspective on what you're seeing there in the ground. Obviously, you have a good China business across all of your segments. So if there's a way to differentiate that as well.

Yes. It's an important question, John. China is an important market for us. It's about 10% of our total revenue. And just as a reminder, our business there, the demand is split about 50-50 between local customers, local demand and demand from customers that are exporting themselves, finished goods out of the China region. So electronics would be that latter kind of example. We do see continued opportunities as we come through 2021 across our businesses. Industrial markets that are attractive for us, electronics, automotive, our safety business, health care. Opportunities in our consumer markets as well in areas like filtration and some of the broader safety products there. In the automotive OEM space, we're focused on, like around the world, driving penetration into new platforms with OEMs in China, leveraging the innovation that's going on. And we grew organically in 2020 versus build rates that were down mid-single digits in China. And build rates in China this year are expected to be up mid-single digits. So that's an attractive market in the middle of everything else that's going on. So if you look at where are we year-to-date, let's say, year-to-date through Q3, we're -- China is up mid-teens for us. And 3 of our businesses grew in the mid-teens. Our smallest business, Consumer, grew high single digits. But the other 3 businesses, Safety and Industrial, Transportation and Electronics, and Health Care all grew in that mid-teens. And so we're focused on those opportunities, like we've been talking about more globally where we have those opportunities to invest for growth. At the same time, supply chain, logistics, other dynamics like port closures are having an impact. And you see that in Chinese exports. I think they're expected now to be down about 10% in Q4. So there are some near-term dynamics there related to the supply chain. But again, it's an important market for us, and we have been driving growth across a broad part of the portfolio.

Great. And maybe that pivots to a question around inventories. So how are you thinking about your customer inventory levels? And then how about your own inventory levels as you look to manage working capital going forward?

Maybe, Monish, I'll maybe say a few words about the customer side. And if you want to talk a little more about where -- how we're focused on it in our operations these days. John, I would say that it's always a focus for us. Whether it's OEMs -- whether it's our OEMs that we serve direct, we're very closely working with them and large retail customers, making sure that we are managing their supply to their needs. You don't want to take OEM production lines down. So we are very close with our OEMs about being well balanced in our inventories. And we see that with exceptions around some of the challenges with raw material supply and semiconductor. That's still the focus. And those are the challenged areas, I would say, in the middle of that work to be in balance with our -- with our OEMs and our retail customers. More broadly, inventory in the channel, we see that balanced again against challenges in the supply chain. So it's an unusual time where our ability to supply with the interruptions in the supply chain is impacting. So if anything, there's a shortage of supply. We look closely at order volume, making sure that we've got a clear view of what the real demand is in the end markets. And then, as I said in the beginning, our teams are working to navigate this fluid environment and deliver for the customers. We're taking extraordinary measures to do that in logistics, in our production facilities. It's -- so there's -- I don't see inventory builds going on. I do see challenges related to the supply side of the equation. And Monish, if you have anything to add?

Yes. So John, to answer your question on inventory internally, I'll just start with long term. We believe the company can grow at or above macro, good margin expansion and strong cash. Just like I talked about leverage, if you ignore the supply chain challenges and what happens in the short run, long term, we should get good leverage and good margin expansion. Similarly, on inventory, working capital is clearly an area that we, as a company, can keep doing more and to drive the strong cash. Inventory reduction is a priority for us. The work that the team has done already through the pandemic is evident where we have managed to control our inventories. Yes, they have crept up over the last few quarters. But that is because you've got longer supply chains, you've got more dynamic supply chains that we're working through. Long term, I don't see that to be an issue. You're going to see that come down. And the reason we will is with the data and data analytics that we can start performing, thanks to all the work that the team has done to streamline the organization, with all the new tools that they have that they can visualize where raw material is as any part of the world, as these supply chains start normalizing, John, you're going to start seeing the working capital returns get better. You've already seen it right now. The team's done a nice job in managing receivables. They're doing a nice job in managing payables. And even on inventory, even though the total is going up as a ratio, it's still not way out of control because we are continuing to do the best we can, but at the same time, making sure we have material available to keep serving our customers. So I would go back to a similar conversation on leverage, once these supply chain challenges slow down, you're going to have very good leverage, good margin expansion, same thing you're going to have with inventory. And working capital is a big piece of how we keep generating good, strong cash for 3M.

Great. And if I may sneak in an investor question here as we're getting close to the end of the time. Can you just talk about customers' acceptance of the price you've put through and how to think about that carrying over into next year if we have continued inflation?

John, I would say the pricing dynamic has been a year-long kind of focus for everyone. And with inflation coming up, we talked about inflation earlier in the year. Monish called it out in first quarter at investor meetings. And it's been something that we've been working to get ahead of with some price increases. I think you see that broadly across manufacturers and retail companies as well. So it's been a focus. We are -- we talked about how we were -- price raws catching up as we went through Q3 and that we were gaining traction as we came into Q4. That's still what we see. We see our price strategy and our price increases gaining traction as we come through the quarter, and that will carry into 2022. It's early to really give a view on how things are going to play out, inflation included in 2022. But certainly, our -- gaining price on traction on price in Q4 is what we're focused on right now.

Okay. Great. So I think we'll end there. Very much would like to thank 3M for being here. And we hope that everyone stays well and safe and look forward to connecting in the new year. Thank you.

All right. Thank you, John.

Thanks for having us, John.

Great. Thank you all. Take care.