3M Company (MMM) Earnings Call Transcript & Summary

Good morning. My name is Brendan Luecke. I cover multi-industrials with Bernstein. It's my great pleasure today to welcome Mike Roman, Chairman and CEO of 3M, joining us again at SDC this year. Thank you for joining us, Mike.

Thank you, Brendan. Thank you for having us.

Absolutely. And we're also joined by Bruce Jermeland from Investor Relations. It's our absolute pleasure to have 3M back one more time. As you remember -- as a reminder to our audience members, we do accept live questions via Pigeonhole. Feel free and submit them. I'll try to work them into discussion as we go.

So Mike, I'd love to kick this off just by looking back a little bit and talking about strategy. So to put it mildly, over the last couple of years, we've seen a very challenging macro environment, and 3M certainly felt it. How is your long-term thinking about the business shifted over this period of time? And what have the key learnings been?

Yes. It's -- maybe I'll come at it from a couple of angles. I'll talk a little bit about kind of where we are in the year and as we progress, but I'll maybe step back first to the pandemic. Certainly, coming through the pandemic, we saw significant trends and changes in end markets. We ramped up N95 production threefold and ramping back off of that. Even this year, we're still coming off of some of the peak sales of N95 respirators. We also saw significant changes in health care, disrupted by the pandemic, and we're still seeing those markets recovering, getting back to prepandemic levels of procedures. And we also saw a big buy forward in consumer electronics. All those market dynamics are impacting our business. It doesn't change our strategy, but it certainly focuses us on those trends in the marketplace. And I would say the pandemic, though all of that, reinforced some of the strengths of 3M, our innovation, our disciplined portfolio management and a focus on our operating model. We've launched into changes in our operating model at the beginning of the pandemic, and we're working to optimize that even as we saw supply chain disruptions. And leveraging that operating model improvement has been an important strategy for us. And I know we'll have a chance to talk more about that in depth, but that's a big area of focus for us and reinforced what we are doing in innovation, really prioritizing where the most attractive markets are for our innovation, where we have the right to win and where we have the opportunity to differentiate ourselves with our unique capabilities. And then that disciplined portfolio has been enabling us to really prioritize where best to make those investments. And so I would say the learning through the pandemic, the changes in the end markets, the trends that we've come through and I would say everything that we've learned about how to optimize our operating model, those are all things that we're incorporating into our strategy. It's also part of, I would say, our -- some of the actions that we announced as we came into the year. Just -- maybe a quick review for everyone just on Q1 and maybe a little bit of our progress in Q2. So Q1, we saw -- the trends were about as expected. The end market trends we saw softness in consumer retail, really a shift from discretionary spending into other consumer categories. We saw consumer electronics decline as expected. We also saw strength in areas like automotive electronics and electrification. Broader industrial, we saw some strengths. And we stayed focused on managing our cost, managing our customer service and delivered sales, EPS, cash flow better than expectations. We also announced some pretty significant actions, and it's around taking stock of some of those learnings. We reduced costs at the center of the company. We simplified our supply chain model and we've streamlined our commercial go-to-market models, all really taking from that learning over the last few years. And I would say focusing our strategy around how we can best prioritize our innovation. And we've called out large commercial areas that we're prioritizing and focused on areas where we can really differentiate ourselves with innovation. And then we're talking about new emerging areas, areas like climate technology, priority for investments for us, industrial automation, the next generation of electronics, consumer electronics is some exciting spaces and areas like sustainable packaging. So it's examples of how we are focusing that strategy based on the trends in the market, and I would say the learnings that we've gone through the last few years.

Excellent. And before we dive any deeper into it, Bruce, I apologize. You wanted to make a statement up front.

Yes. I was just going to remind everyone of our forward-looking statements. During today's discussion, we'll be making predictive statements or forward-looking statements that reflect our current views about 3M's future performance and/or financial results. These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Please refer to Item 1A of our most recent Form 10-K as well as the commitment and contingencies, footnotes in our financial statements, which will provide relevant information or list some of the most important risk factors that could cause actual results to differ from our predictions. So with that, I'll just turn it back to you, Brendan.

All right. Excellent. We'll dive back in here. So over the last couple of years, we've seen a series of portfolio moves at 3M, culminating with the Health Care spin, to complete this later this year. Does this transformational shift really -- how should we think about your organic or inorganic strategy going forward following all of these divestments?

Well, like I said, portfolio -- disciplined portfolio management had never been more clear that, that's an important complement and strategy to what we do in innovation. It's important that we are using it to prioritize where we make our innovation investments, attractive markets that can leverage our differentiated capabilities in technology, manufacturing capabilities. So that's a strategy that we're continuously driving. And it also has us looking at where can we make acquisitions that will complement what we do organically. It also is important for really maximizing value from our portfolio, thinking about what's the best way to operate our businesses as part of our portfolio. And that can lead up to divesting a business. Separating food safety a year ago was part of that strategy. It's a way to maximize the value from that portfolio, combining it with NEOGEN to become a leader in food safety, it's really maximizing value in the portfolio. And Health Care has been a focus for us in portfolio strategies for a number of years. We've made acquisitions like M*Modal and Acelity in 2019, and we've invested organically in R&D and CapEx to help grow that business, leveraging 3M material science but also the digital capabilities we have in areas like health information systems and some on-trend things like biopharma filtration, all areas that we've invested in to help build that business. And it's a diversified health care business that is ready to stand on its own as an independent company, and we see that as a way to create the greatest value. So it's consistent with what we do in that disciplined portfolio management. We continue to look at how to optimize that. And as we look forward, so as we make progress on the spin of Health Care and we look at where 3M company is going to go in the future, so the 3 businesses that will form 3M company, our Safety and Industrial business, our Transportation and Electronics business, our Consumer business, they have attractive markets that we're prioritizing for organic growth. I think what it does is it drives a sharper focus in those areas. You won't have the focus on health care, obviously, you'll be focused on those areas, but they have attractive areas, areas like automotive electrification, the next generation of electronics growth areas, the next-generation consumer electronics, AR/VR, ER. Semiconductor fabrication and the leading-edge technologies that are needed there as that as that cycle turns to growth. So there's a lot of exciting areas there. Our home improvement space and consumer is a place for innovation, large commercial opportunities already, and we have differentiated innovation and technology capabilities. And broader industrial, we have unique positions in multiple markets, and we see trends like industrial automation, where we can bring a combination of material science and digital. So these are all areas that we are focused on investing that same capital allocation model where we're prioritizing organic growth, R&D, CapEx to take advantage of attractive markets where we have a right to win and where we see our technology is differentiating us and giving us a chance to build new businesses and grow those large commercial positions that we have.

Excellent. And restructuring, as you mentioned, it's been a big topic over the past couple of months. the April announcement was the second significant reorg, I believe, in 4 years. Can you sort of walk us through the process? How did you land where you did? And almost more importantly, would you characterize this change as a reaction to market pressure or a push for greater efficiency or maybe a combination of all of the above?

So as you said, Brendan, we had -- this is the second major restructuring. The first was when we announced the shift to a business group-led operating model back at the beginning of 2020. We realigned the businesses in 2019, and then we announced a significant change and subsequent restructuring to position ourselves in that new model. And that had an alignment around the go-to-market models for our businesses that we have today. It was also about our operating model and driving a realignment of our operating model to better serve our customers, to take advantage of the manufacturing capabilities, where we're going with our digital capabilities, where we're going with network optimization, all that part of that. And that timing wasn't perfect. We were right in the teeth of the pandemic. So we launched in the pandemic. I think we took advantage of some of the changes as we went through the pandemic as we ramped up that N95 production, we certainly leveraged some of those capabilities that we were putting in place. But it also meant we had more to do as we came out of the pandemic on optimizing that model. And the actions that we announced in our first quarter earnings call are really taking the next step, taking what we learned, what we talked about earlier, all the things that we learned coming not only through the pandemic, but out of it and seeing the supply chain disruptions and how do you optimize your supply chains, how do you take advantage of the changes in the world of supply chains. And we -- the actions we announced are really threefold. One is to, I would say, streamline the company and reduce costs at the center of the company, to position ourselves for the future. Another part of it was simplifying our supply chains, taking advantage of that learning. And the third was really streamlining, optimizing our go-to-market models based on everything that we've learned over the last few years. We also took, I would say, some insights and learning from preparing for the spin of Health Care. You learn a lot as you look to stand up Health Care as a standalone company as you look back at parentco, the other 3 businesses. And that all was also informed, the actions that we took. So I see it as really the next step and really the second half of the major restructurings that we needed to do to really take full advantage of that new operating model and all the things that we learned in the last few years. So it's really a strategy that serves us well into the future. It certainly will help us as well as we go through some of the uncertainty and the macroeconomic, but it was really based on all those learnings and that next step that we need to take and can take advantage of in our operating model.

Excellent. And between the exit of the PFAS business and then the manufacturing reductions earlier this year and this latest line of restructuring, how should we be thinking about margins maybe in the midterm for 3M?

So the restructurings that we announced, we talked about a charge of $700 million to $900 million, which we'll complete between now and the end of 2024. We talked -- that will drive savings of $700 million to $900 million of pretax savings. And that it will be about half this year. And when we laid that out, if you just look at sales at the level that we have them today, that's 200 to 300 basis points of margin improvement. So we see the actions, not only taking advantage of everything we've learned in optimizing our model, but it's going to help us drive some improved performance and savings and better margins. And then driving growth will -- it's always the best driver of improved margins for us, getting that leverage on growth. So we expect to be able to drive growth as well. But it's just the restructuring that gives you kind of a view that we expect margin improvement there, too.

Okay. Fantastic. So right now, investors are very focused on sort of the shape of the cycle and various demand outlooks. 3M has got a really interesting read. You're such a broad firm. You've got so many different points of view here. I'd love to touch on a few points of the business. So first off, both China and electronics were down pretty sharply this past quarter, but you're expecting a recovery in the back half of the year. Can you give us any color on how things are trending into May?

Yes. Electronics -- we saw consumer electronics, the decline start in the second half of last year as, again, you had a pretty big pull forward in multiple categories of consumer electronics, televisions, notebooks, tablets, mobile devices. So we saw a decline in the second half of last year. That was expected to continue. Certainly a significant decline in that -- those categories in Q1. We expect that to continue into Q2. As we get to the second half of the year, the outlook for the macro, I would say in that marketplace, the easier comps, suggests that we'll get -- we'll see improvement as we go to the back half of the year, even potentially some growth as we get to the end of the year. So kind of the outlook for consumer electronics. We -- the China part of that is impacted, of course, by consumer electronics. First quarter, China was down almost 20%, which was in line with what we expected given what was going on in consumer electronics. I would say COVID having some impact on that in the quarter as it's impacting our economy. The macro outlook for China is to get better and to improve. The second quarter still will be down maybe somewhere around high single digits, somewhere in that range still. So we're still seeing some decline in the China end markets. Really, again, electronics is the driver there. But with the macro outlook, we expect that to improve as we go through here.

Okay. Fantastic. And then this past quarter, we also saw a number of consumer-driven businesses pressured. Where would you say we are in the destocking cycle across that segment? And then if you're looking at Safety and Industrial, what are you seeing in closure and masking systems?

Yes. So consumer -- I touched on consumer electronics because you see that. That's part of what's going on in retail, too. Consumer electronics is being impacted, discretionary spending moving away in addition to the pull forward, and you're seeing consumer spending move from discretionary, what we would call hard lines, into other categories, services, travel, entertainment, food, all areas that are seeing strong consumer spending. So overall, retail spending, consumer spending is staying pretty consistent, but a shift from discretionary in some categories. So we saw that again. That's something we saw in the second half of last year. And on top of that, the large retailers were destocking -- were taking inventory down. They -- as they saw that shift, they had excess inventory, and that was a big strategy. And we saw that continue into Q1 of this year and had impacted our business. As I said at the beginning, it was in line with expectations, but it played out as expected. We expect that to have -- continue in the second quarter. That's part of our view of the second quarter. When -- as I said at the beginning, just maybe a quick view of Q2 for us. As it's in line with what we had said at our Q1 earnings call, $7.7 billion to $7.9 billion in adjusted sales, EPS in the $1.50 to $1.75 range, and that includes the restructuring charges that we've been talking about. So that's $150 million to $250 million of restructuring charges. That's about $0.25 to $0.35 a share. So that's built into that EPS for the second quarter. And we see the -- 2 months in, June is still a big month always, but 2 months in, we see most of the end markets playing now expected. So consumer, they're still, I think, some destocking, some elevated weeks of stock in some of the categories, but they've made a lot of progress. We see that continuing into Q2, but not at the levels of Q1.

Okay. It's good to hear. I mean H2 recovery in auto build rates, it's another piece of that back half story. Is that playing out as expected?

Yes, auto build rates is expected to be positive, the projections were 3.5% to 4% build rate growth in the year. I think it ticked up a little bit with the most recent roll of it. We've been seeing I would say, strong demand in auto electrification, our auto electrification business, which is now over $0.5 billion in revenue. It's up 20% in Q1. And it's a big part of why we expect to continue to outpace those build rates with our growth. But we're seeing -- automotive is a good story. We're seeing strength. The channel inventory is still low. There's not a -- back to stock/destock. This is now an area they're still kind of meeting up with demand. It's better. It's a better position than it was a year ago when they were challenged with disruption from semiconductor availability and so on. But it's -- the build rates -- the outlook for build rates is -- looks good for the year.

Excellent. And then reshoring, huge theme across industrial management for some time now. Are you seeing any signs of this across your businesses in China versus other regions? And have you considered any changes operationally as a result?

Well, Brendan, you know our model. I mean we build our capacity and capabilities close to the customers. So we manufacture a majority of what we sell in every -- in a region in the world. China, for example, we manufacture a majority of what we sell in China in factories, 3M factories in China. That holds around the world. In the U.S., it's the one area of the world where we have significant exports. And we are one of the largest exporters as a company out of the U.S., about $6 billion in exports out of the U.S. It gives us flexibility on changes in supply chains. It also leverages capacity where when you have base capacity that's needed around the world. But our model being close to customers gives us flexibility to adapt as customers move. So we -- I would say we are -- we continue to stay close to customers, looking at what their production plans are, what their investment plans are. We haven't seen major shifts in reshoring at this point. We see the same thing everybody sees, the investment in areas like semiconductor, to bring semiconductor manufacturing back to the U.S. That will represent a pretty significant shift in that market as they build that capacity. Europe wants to do something similar. So we're staying close to that. We have capacity that serves that. We serve a lot of that out of U.S. today. So it would shift where we serve it, but it would largely come out of U.S. factories.

Okay. Fantastic. So looking beyond the cycle, I'd love to touch on 3M's innovation efforts, learnings and maybe opportunities as well. At last year's Investor Day, you spoke to prioritize investments in a number of fast-growing commercial markets. So home improvement, automotive, wound care. Can you offer some color on how your efforts here are progressing? And what does that next tier of opportunities look like?

Yes. And those are important areas for us. They're large commercial ventures already. So you look at automotive electrification. I said it's a $0.5 billion business and we've been prioritizing organic investments there. We're creating new applications, new innovations, new inventions to serve the next-generation battery technologies and assembly methods in electric vehicles. And so that continues to be a priority. Home improvement is represented by a couple of large commercial portfolios, brands that we have, Filtrete brand, home filtration products, Command damage-free hanging. Those are greater than $0.5 billion in revenue today, growing strong. They leverage 3M innovation. So they're -- they get priority because of our right to win, the ability for us to differentiate ourselves. Same in areas of electronics -- new growth areas, electronics, data centers, semiconductor fabrication, even though it's -- the capacity or the output is lower today, it's still a growth segment long term in an area where our innovation can differentiate ourselves. And so we've made good progress with innovations in each of those areas. Health care, we called out wound care, we called out health information system, both areas that we continue to prioritize for investments as we work to set up and spin out an independent health care company. So making good progress, all large commercial areas. And we're excited. There are many trends that we've come out of the pandemic with and, of course, innovations going on in markets around the world, that demand material science innovations, new inventions and material science. It's many ways. It's never been a better time to be a material science innovator. Climate technology -- across climate technology requires material science innovation, whether you're looking at carbon capture or green hydrogen, all of it requires material science innovation. If you look at areas like industrial automation, it's a combination of material science and digital. We have -- we've invented new capabilities, new extrudable versions of our high bond tapes, for example, that are compatible, more compatible with robotics. So you can move to a robotic kind of assembly method where you would have had to do maybe a piecewise step, now you can have a continuous process. Same with our abrasives. Our precision engineered abrasives give you the predictable performance and capabilities and extraordinary performance that enables robotics and industrial automation in those areas. So some exciting areas where we can bring material science together with digital. We're also excited about the next generation of consumer electronics and the demands it puts on, going from nano to sub-nano scale kinds of multilayer optical film capabilities, which we're a leader in being able to innovate. And we've also been excited about sustainable packaging. Things that we can do. We had a long position in the packaging world. You asked the question about closure and masking. This is a business that has leveraged 3M tape and film technologies and continues to be a good business for us. It actually is seeing a little bit of a slowdown as e-commerce and those hard line and discretionary product sales are softer. We're not seeing as much demand, but the channel inventory seems pretty well balanced, but it's an area. And that gives us a position in the world of solving packaging problems, and we see sustainable packaging opportunities with material science that are going to be significant in a fast-growing marketplace. So those are areas that we called out, even as we took the actions in Q1, we called out additional investments in those emerging technology areas. These are already large markets that are looking to grow faster with innovation from material science. So we're excited about those and are prioritizing those alongside some of those larger commercial opportunities that we have.

So -- I mean that sounds like a rich and broad target set, which is very exciting. How do you go about prioritizing the allocation of R&D and CapEx dollars? And have those metrics changed over time?

Well, you -- I would say you learn about where you create the most value. So that's one of the things that changed. We -- it goes back to a disciplined portfolio management. Our -- first of all, our capital allocation priorities remain the same. Our first priority -- my first priority in capital allocation is R&D and CapEx for organic growth. And we know that's the way to create the greatest value for us long term for our customers, for our shareholders. That's the way to drive the differentiated value that we could have as a company. Portfolio management, as I said, the first aspect of our strategy and portfolio is to prioritize where we make those organic investments. And at a simple level, you're looking at what are the most attractive markets where we have the right to win and that can leverage the capabilities that differentiate us, our fundamental strengths, our technology, our manufacturing capabilities, our global capabilities and, in many cases, can take advantage of our brands as well. So it's a -- really putting those 2 together prioritizes where we spend that R&D, where we spend that CapEx. We talked about, for example, 5.5% to 6% to revenue in R&D. We don't spend that uniformly across the company. We're prioritizing that in the greatest value opportunities that we have. And in that portfolio view, that's what's changed. It evolves over time. We continue to evolve it. How do we think about the markets, how do we think about the way we leverage our innovation capabilities, where do we create the greatest value. So we're constantly evaluating and evolving where we have that opportunity to differentiate value the best.