3M Company (MMM) Earnings Call Transcript & Summary

Thanks very much, everyone, for attending. It's my pleasure to have now from 3M, Mike Roman, Chairman and CEO; and Monish Patolawala, the CFO. I think we'll start off perhaps Mike, with some introductory remarks from you. And just firstly, for everyone in the audience, please remember with the QR code, and that take 25 seconds for the audience response survey questions. And please submit those when you have a minute, and we'll disseminate the results in due course. So thanks very much, Mike and Monish, and Mike, over to you.

Thanks, Julian. Maybe just a brief remarks to set up some of the discussion we'll have. So look at 2021, we had strong growth across all 4 of our industry-leading businesses, 9% as an enterprise. We took actions to improve and deliver strong margin and $6 billion of adjusted free cash flow. And that momentum that positions us well as we come into 2022. If you look at '22, we've all been talking about it, there was a lot of uncertainty around some of the challenges we see in the supply chain; though, we expect that to improve as we -- especially as we get into the second half. We see some improving demand in some key end markets, automotive, build rates up, electronics, consumer electronics build rates up. And expectation that elective procedures, which is a big driver of our growth in our healthcare business, getting back to pre-pandemic levels, as we get to the end of the year. So some dynamics there that set us up well. That was all built into our guidance that we talked about last week, 2% to 5% organic growth, $10.15 to $10.65 EPS. We also highlighted a headwind from our disposable respirators, our N95 coming down off the other side of the pandemic demand about $700 million, 2% organic growth and $0.45 in EPS. So if you look through that, it's 4% to 7% organic growth and it's 5% to 10% EPS growth year-over-year. And as we go forward, we're going to stay focused and committed on the things that will continue to drive that performance, leveraging our innovation to drive growth, actively managing our portfolio to add value there, driving operational excellence, leading in sustainability, following through on the commitments we've made there, and meeting our financial commitments as part of our guidance. So that's how we come into the year and look forward to the questions. Turn it back to you.

Great. Maybe firstly, talk a little bit about how demand is trending right now. A lot of companies here for various reasons have quite sort of back-end loaded years in 2022. But just sort of any perspective from you around current demand, any considerations on...

Yes. I highlighted a couple of examples of end markets where we see projections for better demand. Now automotive, up 9% on build rates for the year, but down sequentially and year-over-year Q1. So that gives you a little bit of a view of how they expect that to play out. I think in general, backdrop -- macroeconomic backdrop, GDP, IPI looks pretty good, 4% kind of range. We do -- the supply chain challenge that we see getting better as we go through the year, it really it will show up in how we perform. We're going to get better as we go through the year. We're going to see margin improvement as we go through the year. We're going to see some of those end markets get a little better. Certainly, the supply chain improvements will help as well. So I think it's kind of improvement as we go through the year. And absent the uncertainty around COVID or maybe some of the geopolitical risks that's out there, the macro looks good. And we see -- and we've talked about it in '21, even as we came through some of the worst of the supply chain challenges, we saw good end market demand, and we see that coming in...

Just I'll add, Julian, when you think about -- since you asked seasonality, a couple of things for 1Q sequentially, you would see auto builds are projected to be down 2% sequentially and down 2% year-on-year. Elective procedures on the healthcare medical side seem to be flat to Q4, as labor continues to be short in the hospitals and they'll see how Omicron plays out. N95 masks, we're down $100 million to $150 million in the first year on a year-over-year basis. We're going to continue to see investments in growth productivity, sustainability as the year builds, at the same time, we've got good margin -- or sorry, not margin, good productivity in our factories. So that's going to continue using daily management, data analytics. Couple of other headwinds that we are working through. As you know, the Combat Arms cases, we've got 5 bellwethers in the first half. So we're going to work through that. The second piece is, Mike had mentioned during Investor Day, we have -- we are working through a couple of issues in our Belgium facility in Zwijndrecht. We've got a wastewater permit that we are working actively with authorities. It could be significant if we have to shut down the whole plant, but we've got the best engineers working on it. So in summary -- and then I would say inflation and price. Price momentum continues. You saw we got 2.6% price increase in the fourth quarter. That momentum continues. And inflation is somewhere between $200 million and $250 million for the first quarter, and that's mainly driven by the fact on how we exited fourth quarter. And if everyone remembers, 1Q of last year, most companies saw no inflation. So you're going to see that as a headwind. Sequentially, I would say the pace of inflation has slowed down. We'll see what the geopolitical crisis brings and where oil goes. But overall, if I had to summarize, Q1 is very similar to Q4, but good strong end markets and 3M will continue to drive growth above macro, get margin expansion through the year, as the year progresses. And then we'll keep fighting in the first quarter, the headwinds that we...

If you look at inventories as a topic, I think inventory to sales at 3M has been moving up a bit, because of supply chain constraints and so forth. When you look at the inventory levels of your customers or channel partners, do you see the same phenomenon around sort of inventories rising in certain areas? Or do you think it's pretty lean channels you're selling?

Yes, we've talked about this in other years, right? It's always an important measure for us to be watching, looking at how we're selling and selling out of the channels. You're right, the supply chain challenges have increased inventory on the water, goods in transit and increase -- a big part of the increase we're seeing. I think it's -- we've seen some unusual inventory dynamics. We called out the automotive Q3, Q4 dynamic that we saw. We saw our revenue outpacing build rates significantly and saw inventory building in the automotive OEMs. Called that out at our Q3 earnings call and then expected it to play through in Q4, it did. And so if you look at the total of second half, it looks pretty normal. But I think that's just representative of some of the challenges that are going on in the channel. In general, you see more challenge around getting products to meet your demand, whether it's a retail customer or an OEM that's trying to keep their production running. And you certainly see that in semiconductors, but you see it more broadly than that. Just given the logistics challenges, the interruption in light chain from raw material supply and things like that. So 1 of the things we watch too is backlog. And that's -- so that's -- backlogs are elevated, inventory is elevated, because of things like goods in transit. So it's a little different environment. So we're watching all of that to really get a view of how is this going to play through, how will supply chains recover and how do we see it. And again, Monish talked about it on the earnings call, I did, I think, as well, focus we're putting is on customer service, delivering for our customers in the middle of this. So we're doing some extraordinary things to work through all that -- and spending money to deliver where we need to. Logistics, we've -- we're 1 of the larger exporters out of the United States. And so we've chartered more aircraft to get products to customers around the world from our U.S. operations, as 1 example of some of the measures that we're taking.

And you mentioned that. Yes, the automotive example is a very interesting one, because you saw that the OEM production will accelerate but that led to a sort of a destock at the suppliers. Do you think that type of scenario is unique to auto or you could see it similar in other verticals?

Seems kind of unique to the situation we're in, in auto given the semiconductor challenge, I think that's a big part of it. So as long as that continues to be a challenge, you could see dynamics like that. You see OEMs reacting to that. There's OEMs that are cutting production. And then you can see -- like we saw reaction in inventory. They built -- they got ready for semiconductors and then they had the wage percentage.

Yes. But in general, that's not a major concern. I think the demand is...

No, I think it's back to -- the challenge right now is meeting demand and the logistics challenges and raw material supply and availability, that's really the focus. It's -- we are confident that we'll work through the inventory as supply chains return. And we've put a focus on that. We are confident that we can manage that as we -- it will take some work to work through that, but that's something that as supply chains return to normal, we'll be focused on.

And what's the update in sort of electronics. That side of -- I mean it's a volatile industry historically, maybe not been super volatile at 3M recently. It doesn't come up in the inventory conversation. So just wanted sort of thoughts around that business, inventory there, customer demand, how you see the...

Well, they're facing some of the same challenges, electronics for us is multiple markets, maybe first of all. Consumer electronics is about half of our electronics business. So that has got similar dynamics to other OEMs that are looking for semiconductors. So that's part of what's going on there. The outlook for this year is those build rates to go up, consumer electronics grow, as Monish was saying, Q1 looks a lot like Q4, and we don't see electronics getting off to a fast start against that. I think they're just challenged in the supply chain environment. It is going to take improving as we go through the year. So I think it will get better as we go through the year. There's other parts of electronics for us, too. There's semiconductor manufacturing. The demand there is very strong. And we're serving that and driving it back to doing what we need to do to serve customers. That's an area where we are working hard to be able to deliver for those customers. Obviously, it plays an important role in being able to ramp up capacity and so on. But there's other areas like data centers and factory automation, all of those are areas that we see strong end market demand. So I think I agree with the projections that electronics should see a better year, but it -- at the start of the year, you're going to have the supply chain challenges. The inventory side of it, same thing. I don't -- it's more about getting product to them. We don't see them building excess inventory and that would dampen later demand or think more likely we're working off of backlog, how do we address backlog.

And when you talked about the sort of the margins -- the progression of margin year-on-year getting better. So how much of that is not just about comps, not about [ self-help ] Asia. Like how much of that guidance is based on external things, not part of this year-on-year, how...

Yes. So 1 of the things I've mentioned is back to our philosophy, operating philosophy, embracing the red, finding areas that we can keep driving efficiency. The 1 I would say, Julian, may look at our 30% to 40% guide that we've given you on operating. The first 1 is volume. Volume because that's the best leverage. And I think you're going to see, as things stabilize in the world, volume continues to keep growing at semiconductor. So that's the first thing that will give us good leverage. The second is the work that we are doing in the factories using data analytics, digital yield efficiency is clearly an area that you're going to see, plus it gets helped by the fact our hope is when the second half supply chain stabilize, some of the inefficiencies that we saw in '21 start getting better. The third -- so those are the 2 that add to the positive side. Then we are going to keep growing in -- we're going to invest in growth, productivity and sustainability. But we're going to measure ourselves, and we're going to go as we go. Wherever we see an opportunity, we're going to keep going ahead and investing. And then the last 1 is we are managing all the headwinds, whether it's a factory in Belgium, whether it is the legal headwinds with Combat Arms and PFAS is another piece that -- so when I look at leverage and the work that the team has done as well as you start looking at the restructuring program, the carryover benefits as the charges start playing out, you actually start seeing all of that show up as the year goes on. So that's the way. So I would say there's some piece external. There's a piece of a comp, but there's execution too, that you're seeing that will keep getting better and better as the year goes...

And then on the Belgian plant, you've mentioned it a couple of times here. You mentioned that at the Investor Day, a couple of times. Any -- what's the sort of milestones or updates you think about? And I suppose this issue has been live a few months. You've had time to prepare contingencies at other 3M plants globally. I suppose the longer it goes on without a resolution, as your inventories at the plant are coming down, but you're also able to set up -- like how serious could it be...

Yes. Let me just kind of frame it up for you. So we've been in Zwijndrecht for 50 years. Now, it's 1 of our 6 larger chemical manufacturing facilities around the world. The important new customers and also to input materials to other factories around the world. We talked about the importance of it around -- it's 1 of those areas that we've put as part of our environmental stewardship commitment last year to invest in water quality and water use. We're committed to EUR 125 million investment in Zwijndrecht. And that's part of the commitment to the community that we had for those 50 years and going forward. So it's an important part of our manufacturing globally. And we've been working with local authorities on the safety measure that shut down certain operations, not the entire factory, but certain operations within the factory. And then also with the same local authorities around water regulations as we move forward. And so that -- we're in the middle of that. Depending on how that progresses, that can have an impact on the whole plant and -- which would directly impact customers and other facilities for 3M. So it's something we're in the middle of -- we're really in the middle of that process, and we'll update as we get further along as we have appropriate information.

But it is something that you can -- what you do in that plant with some CapEx dollars would be [indiscernible]?

Well, I would say again, it's 1 of our 6 factors. So it's an important part of it without talking about the size of the plant. And so it's certainly something that we're looking at as part of that...

And then when we look at sort of operating leverage and operating margins and some of that like had in place. Where is 3M on kind of rolling out more of that [indiscernible]. How much has changed in the last [indiscernible]. Is there a need a couple of layers down in the operating management [indiscernible]

Yes. I would first start by saying 3M has had a long history of -- so this is not new to 3M from that perspective. And so therefore, when I joined 18 months ago, it was less, not to see that I would be in a company that supports Lean and Six Sigma, and you can call it either. I would say, as I've mentioned, this -- we have made good progress in the last 18 months on starting to face reality earlier. We have made good progress in identifying areas of "waste," which sounds like a bad word, but it's actually an opportunity for us to do more. The teams are accepting -- when you start accepting reality faster, you start making progress faster. There's a lot more visualization tools that we have put into place that allow us to look at end-to-end. For example, I would say, Julian, even inventory, though, it appears elevated based on what we are seeing in the supply chain, you actually look at the work the teams have done and reducing inventory, excluding what's on the water, which we can't control, because of the supply chain chip shortages. You can actually see where we are able to see end-to-end inventory. We're able to see demand signals fast. If we just apply that to overall working capital, the last 18 months, we have reduced working capital cycle by 12 days. Our net debt-to-EBITDA ratio, which was 2.3 is down to 1.4, part of it is the cash that we generate to the model. But part of it is the progress that team's made on working capital. And that's just 1 example of embracing the red, where the teams looked at past dues, billing cycle, looked at inventory demand, terms with suppliers, and each 1 of them are being attacked, but it's a cultural change. It doesn't happen overnight. There are some pockets that do a great job at accepting this. There are some that we are working through. But my confidence comes from the fact that as this thing gets old, takes hold over the years, actually generates a lot of value.

And if we look at the -- 3M has had a few rounds of, say, headcount rationalization as a sort of brute force way of margins getting costs down. It's been about 15 months since the last announcement and getting close to the run rate savings from that year. Once that's in the run rate, should we expect another round of fixed cost action? Where do you think 3M is on that...

Yes. I would put it in frame. We talked about it at the Investor Day last week, what we've done over the last several years. And I started with the realignment of 4 go-to-market model-driven business groups, leaders in their industries, focused on customers. As part of that, we went to a business group-led model globally. We eliminated the country business leadership statutory structure, and went to business driven through to local execution. We added an end-to-end enterprise operations underneath that. The reason I go back to that is that's a foundation for us that really drives the 3M model, drives the ability for us to leverage our innovation, to drive growth, focus on operational excellence, deliver greater efficiencies, and execute better. I think, get better visibility end-to-end on embracing the red. And so that also has the benefit is it's helping to streamline the company. So the restructuring -- we had a restructuring in the middle of the pandemic that was really pandemic-driven. That wasn't the larger at the -- as we got through the end of 2020, we took a step in the new model and how we can streamline the enterprise. And so that was really taking advantage of what we had done end-to-end on our commercial side and also on the operational side. So I think there's -- we're still in the process of optimizing that whole model. And I think there's more to do in terms of how we streamline it. Monish talked last week about our digital strategy. That's going to enable us to better leverage that end-to-end model and continue to streamline. So I think it's -- what we do going forward is it's -- these are less about economic reactions or market reactions. It's more about our opportunity to really streamline and drive the best performance model.

And if we look at the portfolio for a second, you announced the [indiscernible]. You talked a lot about portfolio prioritization in late 2018 [indiscernible] as well. So I suppose, how -- when you look at the business today, do you worry that it's too large or complex by good earnings and cash flow growth consistently and that necessitates aggressive pruning like food safety or I think it's too early to tell, let that reorganization play out further for deciding any [indiscernible]?

Yes. Well, why we're optimizing that model, we are focused on delivering growth above macro and improving margins and strong cash flow. And we're driving that from a commercial point of view, leveraging our innovation, really enables us to focus our investments in markets where we have the best opportunity to leverage the 3M fundamental strengths, our innovation, our technology, our manufacturing capabilities. As you do that, portfolio is the other critical priority, actively managing our portfolio has been something we've talked about even prior to 2018. But we continue to actively manage our portfolio. It's really important for us in how we prioritize organic investments. It's how we think about where we want to make acquisitions that we can bring into 3M and take advantage of the fundamental strengths in more attractive markets and get greater in the sum of the parts, when we make an acquisition. And then it's about optimizing -- really maximizing value -- shareholder value from our portfolio. So it is a priority and an ongoing process. It's not a pick it up once a year or every couple of years or on a 3-year cycle. We're looking at it. We've got a pipeline of activities that we're looking at. How do we maximize the value across our portfolio and we'll take action. Sometimes, we change how we operate a business, because we can create the most value managing it for cash. We've talked about some examples of that. We will take actions to divest businesses that there's another ownership that can create greater value. And that helps unlock value for shareholders and create -- maybe avoid creating less value over time. And then you have opportunities like food safety, where you can really unlock value around the best way to win in the marketplace with that business by combining it with Neogen and to unlock value for our shareholders by moving it to a 30-plus multiple business that goes through an RMP. So we're looking at all of that, and it's -- there's more to do there. I think markets change, our view of where our priorities evolve over time, and that's all going to feed our portfolio action. So it's critical that we do both of those to deliver on the goals that we have. So it drives that -- the growth strategies and operational excellence to support that, the strong cash, and then really focus on actively managing our portfolio.

Then when we look at some of the liability side of things. Is there any way of sizing approximately the sort of a headwind from [indiscernible] drag on profit [indiscernible] and then secondly, sort of taking a step back, we've seen different companies adopt different mechanisms for handling liabilities. There's a case going on right now with J&J, for example. So I guess, how wide is 3M's [indiscernible] looking for [indiscernible] solutions just to make sure that we're not [indiscernible] 5 years.

Yes. I can talk a little bit about where are we in some of our litigation matters and Monish can talk a little bit about how some of this is impacting us as legal costs and so on. I would say where are we in -- the 2 litigation matters that we talked mostly about today and one-on-ones, PFAS and Combat Arms. And we're in -- Combat Arms, for example, we're in the middle of bellwether trials. We've had 11. We won 5 verdicts. We've lost 6. There have been 8 dismissals of claims as part of that process. There's 5 more bellwethers ahead of us in the next 3 months. So we're working through that process. And we're always evaluating our legal strategies. We're evaluating how do we help with the uncertainty that's around that for investors, shareholders. And there's an uncertainty around time and there's uncertainty around size of the potential impact of the litigation. We're just at the point in the process, it's too early to really put some -- put a ring fence around any of that. PFAS, similarly, I would say PFAS, maybe the 1 exception there as we took a reserve in 2019, and we've been working on where we historically manufactured PFOA, PFOS and we follow through on those commitments. We've been following through. We've made considerable progress. And so that's an example where we're able to have something that was probable and estimable. It's our factories, and we're working with the communities that we're part of there. Beyond that, there's multi-district litigation, which will have the first court date next year -- early next year. And so we're going to have to work through some of those processes as well. That's the case where it's multiple companies and goes beyond only about 3M. So I think that's kind of frames up where we're at it. It's -- and as always, we're committed to update shareholders as we have more to share.

Just I would say on SIBG, safety, industrial, there are 2 pieces -- 3 pieces. One is the team is going to continue to drive price to get the margin going through productivity in the factories. The things that take away from it, the big 1 is disposable respirators down. That has $0.45 of EPS impact at the company level that will hit SIBG squarely. That's a large number. And then Combat Arms, the cost of litigation shows up in the SIBG business. And that's going to be determined by the volume that of cases see. Based on what we know right now, we think that cost is going to be higher on a year-over-year basis, and that will show up. But overall, I would say Mike Vale and team are laser-focused on continuing to drive growth and margin expansion -- items through a lot of work that they're doing through pricing as well as driving [indiscernible] while still investing in areas that they...

When we look at the healthcare business within 3M, you look at health care assets in general, they're very highly valued on the whole public markets. How optimistic do you feel on the growth outlook in healthcare? Do you find that -- yes, it's a slightly different market in many respects, but there's no reason [indiscernible] the current structure.

Healthcare is a very attractive end market for us, right? It's got good demographics, aging population. So those are drivers that make it a GDP plus kind of opportunity. You've seen we've focused on some acquisitions in that space to help position us to attractive parts of the market, give us capabilities to be able to create greater value from that growth and really deliver shareholder value out of that. So those are certainly, I think, testimony that we see this as an attractive space. We also prioritized it for organic investments. We've obviously also announced the spin or the RMP of food safety with Neogen. So it is an area of our portfolio that has been attractive in terms of growth and value that it can create. Monish has got a longer, deeper experience in healthcare. I'm always trying to catch up with him. So I can't kind of match his understanding of it, but he can give his view of it.

Listen, I would say the product facility is a good acquisition for 3M. It gets us into spaces that you would have normally not gotten just 3M [indiscernible]. Secondly, elective procedures are going to go up. As we said, it's going to be Q4 by the time. But then you know there's pent-up demand. So that continues. So Mike also said aging population. So that keeps going. Then you've got to take the oral care business. Where you look at emerging markets and say oral care in the U.S. where we play, slows down a little bit, because some people's oral health has got better. But think about all the emerging markets where we can go and play in the composites that we do. And then you've got to take our health information systems business, which is a world-class business. Again, with the amount of data, with the desire to do community health, patient management all of that is where 3M [indiscernible]. I mean, we are in the revenue cycle space. Marry that with the M*Modal business, which allows you to get efficiency for providers. You know that's where there's a lot of strain from a labor perspective. And then the last business, which is our SPSP or purification business, Biologics is a piece of this and biopharma filtration, which is 1/3 of that business, but that grew 20% plus last year. And as long as Biologics keep going, Julian, you know they're going to need filtration, and that industry is growing 8%, 10% each year, just the biologics industry. So when you look at all the spaces that 3M can play in, this could be very attractive.

Do you think that, that value for now, most of it can maximize...

Yes, so back to portfolio. We're always looking at what do we need to do differently to maximize. Acquisitions came out of that. The food safety was really about maximizing shareholder value and positioning that business. In that marketplace, combining with Neogen creates a leader in that marketplace. That's important part of the strategy for creating value.

Perfect. Well, I'm afraid we're out of time. Please, if you get a second, have a go at the audience survey and other than that, thanks very much, Mike.

Thanks, Julian.

Thank you for [ having ] us.

Thanks a lot.