3M Company (MMM) Earnings Call Transcript & Summary

Welcome, everyone, to this morning's Industrial Select Conference. It's my pleasure to start today with 3M. We have Mike Roman, Chairman and CEO; and also Monish Patolawala, Chief Financial Officer. So welcome, Mike and Monish.

Maybe first question, we'll just start with sort of current demand trends, in particular, some of those areas like industrial, destock, China, electronics, those seem most topical for investors. So any updated thoughts on kind of what you're seeing there?

Yes. Julian, first of all, thanks for having us here today. It's great to be here. I thought I'd maybe just frame up a little bit. I don't want to try to pre-answer all your questions, but I wanted to just provide a frame, and I'll get to that as part of it. I would say 2023 was an important and pivotal year for us as a company. I know, really, came from what we did with our focus on 3 priorities, the first was really improving the performance of the 3M model and what we did to execute there. It's about what we did to progress the spin of our health care business, a company that's now going to be named Solventum. And it was also about reducing risk and uncertainty for the company. And then first one, we delivered a strong performance in 2023 because of our focus on improving performance. We delivered above our expectations from the beginning of the year on EPS and cash. We expanded margins. When you exclude restructuring, we expanded margins 60 basis points. EPS was $9.24 against initial guide of $8.50 to $9. We grew adjusted free cash flow 30% to $6.3 billion. And free cash flow conversion, 123%, up 37 basis points. Just a reflection on the strong, reliable cash generator that we are as a company. We took the biggest restructuring in the history of the company, and that was in a top-down eliminate 10% of the headcount. It was to really accomplish some strategies we're driving, streamline the organization end to end and -- with a big focus on supply chain and what -- where we were going to drive improved performance in supply chain. And that focus on following through an improved performance is a big part of this. It was about leaning out the center of the company in anticipation of the spin of health care to start to take on some of those stranded costs. It was about aligning our businesses closer to customers, and we are leveraging that into the margin performance that we saw during the year. We also are creating space to invest, and invest in growth and sustainability and productivity. So very important progress there. And it brings momentum into 2024. These 3 priorities are what we're focused on this year. That's why I spent a moment on those. Turning to the spin of health care, Solventum. We made great progress. Our teams have done a great job. We've assembled a strong team under Brian Hanson for Solventum, as they become a public company. Our Form 10 was made public on Tuesday. That highlighted now a targeted date of April 1 for the hard spin. And that's subject to Board approval, of course, and other conditions that we've laid out in our SEC filings. We are going out with the leverage that was part of our guidance originally, so 3.5x. We had an investment grade for Solventum. That means they'll be looking to borrow $8.4 billion. They'll retain $600 million in cash. Net of fees, approximately $7.7 million in proceeds coming back to the 3M company. And at the same, we followed through on the guidance that we have at the beginning that we'll hold a 19.9% stake and become monetized over the first 5 years. So we're excited. We're in the final stages here of standing up 2 world-class public companies. So great progress there. And then the third one, reducing risk uncertainty, we had 2 important settlements announced last year, public water suppliers in June and Combat Arms in August, making very good progress on both of those. Combat Arms, we announced in January that 3M and the plaintiffs are reaching an agreement to settle all the settlement requirements in cash, and that was a good step for us. We also had an initial settlement, actually the assessment of the settlement come at -- on January 5. And that -- we came out of that talking about we're on track for the 98%. There will be a final settlement agreement or finalization on March 25. So making good progress on that. All parties are working together towards successful conclusion of the settlement. Public water supplier, we continue making good progress in the settlement. We had a final approval meeting on February 2. We're still awaiting court ruling on that. And one thing to note is the Court of Judge extended the opt back in. So this is for any public water suppliers that opted out, they have an opportunity to opt back in between now and March 1. So that's a good step in terms of progressing through this and getting to that final ruling from the court. And then the other one to note on risk and uncertainty, we continue to make very good progress on exiting PFAS manufacturing, something we announced at the end of '22 for completion by the end of '25. And we're making good progress. Our volumes are down 20%, which reflects working with customers to transition them and be on track for that exit. So then back to your question, how are we looking at 2024? What are we seeing? We said that by Q4 earnings call, Q1 looks a lot like Q4, and it's really about the dynamics. We see consumer electronics stabilizing, which we called in Q4 kind of flattening out against year-over-year comparisons. Semiconductors, still soft. Both are expected to improve as we go through the year. But in Q1, we're still seeing those same dynamics. We're seeing mixed end market dynamics in industrial. Consumer retail is still, I would say, muted and soft in -- as we start the year, so similar to what we saw in Q4. Geographically, the U.S. is relatively strong for us. Europe, Asia, China, also, I would say, soft, muted as we start the year. Just watching those closely, China, in particular, we're watching closely as we come out of Lunar New Year. When you look at the macro around the world, it's low single digits for GDP, IPI. China is mid-single digits. So we're watching to see how that progresses. We'll update the total year guidance after the hard spin, but just -- I would just confirm what we have said about Q1. We're still seeing at approximately $7.6 billion and we've ha no -- we're still looking at EPS at $2.15, in that range. And then our operating margin is still looking at the same kind of range, 19.5% to 20%, up 250 basis points over year, reflecting continued improvements in our execution operations. So we're excited about the year. We committed to what we've laid out, and we are confident we'll have another successful year in '24. So I'll give it to you for all the rest of the questions that I have not been answered.

Thanks very much, Mike. I think maybe on that organic sales point, any thoughts around sort of inventory levels at customers, particularly in markets like electronics or in safety and industrial? Do you get the sense that those could be poised for some restock later this year or pick-up in final demand? How do you assess kind of where we are now after what's been 5, 6 quarters of sort of muted demand?

Yes. I would say, broadly speaking, inventory in the channel is pretty stable against that dynamic that I just talked about, and then partially because of that dynamic is kind of moving sideways. Not every market is doing that. But I would say, in general, it's stable. A couple of things that are notable. This time last year, we were talking about significant inventory reductions in retail, and that played out for the year, and that's relatively stable at this point. Electronics has restarted the downturn at the end of '22, really. And so they've stabilized, relatively speaking. And I -- before you see an inflection point, in a recovery, you got to see an inflection point in demand, so that recovery in electronics would have to be there. The one area that we called out in Q4 is some destocking in industrial channels, and some of it was certainly due to the fact that supply chain's performance was getting better, and they were taking on safety stock. Some of it looks like it's caution -- cautious outlook for -- and it's hard to tell what's demand and what's inventory management. That -- it's not something that we've been quantifying as something big and material, but it is a dynamic. And I would attribute a lot of it to the -- just the improving supply chain. Up to this point, you'll see they'll react to whatever they think the demand is going to be as they look.

Perfect. And when you think about sort of price versus volume, I know 3M doesn't break it out explicitly sort of by quarter anymore. But any thoughts around sort of how much you expect the price tailwind to narrow just the kind of broader inflation and the sort of net of price versus raws in your market as we see it?

So I would just start first, Julian. As we went through the last few years, the team has done a fantastic job of starting to monitor inflation from multiple sources. We've also had good success in raising prices to offset inflation, which we've done last year and the year before. We would also -- as I look at inflation, we are seeing certain commodities continue to be inflationary. And then you've got labor that still has inflation. In 2024, the team is planning to raise prices to offset that. So we should be able to offset those 2, and that's our current plan. I would also tell you, the team is doing a lot around fuel sourcing, driving yields and efficiencies in the factories, different ways that you can address the cost of goods sold. And as you know, you've followed 3M for a long time, our prices are not formulaic in every market. We go through multiple channels. We go through markets. We go through competitive position. And we look at all of that and factor that in. In the long term, or even if you look at this chain, you look at the long term going forward, 3M has always been able to get good price, and part of it is because of the value that they create for customers. And I don't see that changing. So '24, the plan is to have price that will offset inflation. And we always feel like -- we always feel that the work that we do, that there's always opportunity for us to keep doing that equation to remain positive.

Perfect. And then when we think about kind of medium-term organic growth for the company, in the past, you've talked about maybe something relative to IPI or there was a 3% to 5% type of ambition from 6 years ago. How do you see the sort of approximate through-cycle growth rate of the company once Solventum comes out?

Yes. Just to frame up, that 3% to 5% was a view of IPI being higher than it is today, for sure. That was part of it. The way we're looking at it right now, medium term is 2024. So when we guided 2024, if you look at it, we said flat to 2% organic growth, which includes portfolio actions that we're taking and about 100 basis points of portfolio action. So it's 1% to 3% organic growth across the business, ex portfolio actions, which IPI GDP is about the middle of that. So it's -- and I don't -- we certainly think about the macro and the outlook for the macro as we guide for the year. But we're looking at markets. We're looking at where we are invested, where we are growing, where we are close to customers. And I would say that's what's driving the guidance in the near term and medium term is how do we look at those markets. There's been other times like coming out of a Great Recession, where all markets were synched together. Even coming out of pandemic, all markets were synched for maybe a relatively short period of time. That's not true. The markets are diverging. Just look at how consumer spending has shifted in the last 18 months. So it's a -- it's something that's very market specific. So you look at our major markets, consumer electronics, we've talked a bit about already. Automotive had strong growth last year. Beginning of the year, we were looking at build rates of 3.4%, 3.5%, would double that by the end of the year. So we had a strong year in build rates, and we continue to outgrow those build rates. And as we look at 2024, it's flat to slightly down in build rates projections. We expect to outgrow those build rates. So we're kind of building our view of medium term off of that. And we look at multi-industrial -- the industrial markets and how are those markets. I'd say it's mixed. There are some markets geographically and otherwise that are performing better and others that aren't. And so you're -- we're taking stock of that all the time. It's what went into that. It happens to kind of have GDP, IPI at the center of it because of the projection there, but it's really built up by those markets.

Got it. And when we think about that sort of 2% or so underlying organic growth rate this year, is that sort of split -- is there a minimal kind of volume growth, it's mostly price driven? Is that the way to think about that?

Well, we see volume growth coming back as part of this. And it gets -- it's -- that's the range a little bit, it depends on the end markets. So that goes into it. We continue to -- our organic growth is driven by our investment in innovation. And to a degree, the -- when I talked about the beginning driving improvement in our performance, that is an enabler for organic growth, too. You're improving your margins, your gross margins. You're driving greater cash efficiency. You're enabling yourself to perform better for your customers, improving service, and that adds to it as well. But where we are investing in significant commercial sized opportunities that we have today, where our innovation can play that in attractive markets, that's what will really drive that organic volume growth improvement as we go.

And when we think about sort of pruning elements, is that something that investors should expect and sort of maybe several years, you have that 100 basis point headwind on the top line? And then on the other side of it, there some areas where maybe you're taking share that could offset the pruning aspect. I think you talked about outgrowing global auto builds, for example. Any other areas where you think over 3 to 5 years, 3M could pay share in these areas? And then any thoughts on the scale of that pruning after this year?

Yes. I think maybe I'll start with share. It's an important strategy. We are -- we need to be competitive in our markets and take share. And we do that partly with our innovation. What I said at the beginning, aligning our business closer to our customers. That's about being competitive and winning share in the marketplace, and that's an important part of the strategy. We also look at where can we leverage our innovation, responding to customers. Our innovation model starts with the customer. It's customer backed. We're close to them. We understand their businesses. We have close relationships. The majority of what -- our revenue is specified. That's only been a regular with our customers. So there's a very close relationship. And so winning in the market and driving growth, focusing, and I would say we prioritize our investments, capital and R&D to the most attractive markets. So we want to be focused on winning in markets that are attractive, growing better than macro, if you will, and also where we have a strong right to win. So that positions us to try to take share in those markets broadly. So I think that's -- that will be the driver for us of organic growth as we move ahead. We also are investing in where we can build new businesses. So there's areas of strength commercially, safety, home improvement, electronics, automotive, where we are well positioned, and we see opportunity for our material science. And so that's more about new penetration than it is about share in a sense. And then we have emerging technology areas that are going to be about building new businesses, and that's an important contributor to our growth. And we've called out climate technology. For example, we've got opportunities broadly across climate technology, emission reduction, energy transition, adaptation, various areas of climate technology. So there's a number of strategies there, close to customers, new penetration and building new businesses, that will also be part of how we drive volume growth as we go.

Right. And the point on pruning, is that 100 bps a year for several years? Or do you think a lot of it is done now as a kind of cleanup?

So the other strategy that really complements innovation on the portfolio management, and we talked a lot about this, it's a continuous process. There is -- really, at a simple level, there's 3 things that we do. We prioritize where we invest organically, like I've just described. We look at complementary M&A to our portfolio where we can drive opportunities into more attractive markets, leverage our synergies of 3M, get greater than the sum of the parts from acquisitions. And then optimizing the value from our portfolio. And the action that we talked about at the Q4 earnings call, geographic prioritization and also what we're doing in the consumer business, that's about really focusing on how to optimize value out of that portfolio. So geographically, moving to an export model in 30 countries around the world, enabling us to prioritize resources for other parts of the world where we can drive strong returns. So it's -- there's a near-term headwind in revenue, but it positions us for stronger margins, stronger cash flow. And I believe it will focus us on the areas that we can drive growth, and it will give us an opportunity to improve growth as well. So it's a strategy. What we have in front of us right now is the 2 actions that we talked about, but we're going to be continuously looking at our portfolio and saying, "Where else can we help ourselves near term in terms of performance, the returns, if you will, and then longer term and positioning us for better growth as an overall company?" And consumer is a good example of that. About 5% of the consumer business, we looked at portfolio in categories, we didn't have the strong right to win. It wasn't being differentiated. We have other parts of those categories and other categories where we have strong right to win, strong differentiation. By taking those actions, not only do we improve margin and cash flow, we create space to consumer investments, advertising, merchandising, other investments, to those areas where we do have a strong opportunity to grow. So you get -- you can build momentum on.

Great. And then on the margin front, I think you've talked about up to 100 basis points of total margin expansion this year. When we think about 2025, let's say, you've got similar tailwinds from savings, less of a headwind from restructuring and potentially more volume leverage. And so we should expect 2025 to be, in theory, a very strong margin year. And then after that, we'd settle back into that 30%, 40% incremental margin sort of placeholders.

Yes. So Julian, we haven't given guidance for 2025. I also would say, a lot of the restructuring benefits, we will rebaseline once the hard spin is done, so you'll have the right math to go up. What I would start by saying is just where Mike said. Three things that the teams focused on: target growth; margin expansion; and cash. How do you get margin expansion? You're going to get it from supply chain efficiencies, and you're getting it from restructuring program. The restructuring program is a different way of working. So it's a new way of platform. So it's in everything we do. For example, geographic prioritization, you're seeing the saving in the restructuring program. You've seen some of it show up as a negative in revenue because now you're going through distributor margins. So distributor margin is different from what we would have seen the cost. So when you look at all of that put together, our equation in our heads are you've got supply chain efficiencies, volume leverage, restructuring benefits, less headwinds that you said -- as you called out, offset by the favorable amount of investments in growth, productivity, sustainability and investments in our workforce, which is normal wages, et cetera. When you put that whole equation together is where you get good leverage. And the teams are focused on continuing to drive operating leverage and its margin expansion because that not only gives us more cash, but it also allows us to be more competitive, return capital to shareholders, et cetera. So big focus on that. And when we come back on the investor event after the spin, I think we'll just walk you through that and give you the outlook. But as you said, for 2024, with the no spin scenario, the plan was 75 to 100 basis points of margin expansion, which is in addition to the 280 basis points year-on-year last year in the second half. So you can see -- you can start seeing these actions going up in our margin rate.

How do we think about kind of stranded costs now that there's a firm date sort of the spin?

So we're working through that. Again, as we meet you all post spin, we'll walk you through that and give you clarity. The word stranded costs on our definition, because everyone's got a little definition, is when you have costs that you can't commensurate, reduce with volume, in our view, that's stranded cost, a negative leverage, which you avoid and don't want to deal with. So some of the restructuring actions that we have taken allowed us to eat into some of that portion of that stranded cost that won't have existed, that we would have had if we had not taken these actions. So we're working through that. Now that we've got a date locked in, we just got to work through all the math on who goes where and what the costs look like. We get a clean quarter on, what all the moving pieces are, and we'll come back and give you the big picture.

On the balance sheet, as you said, some of the big liabilities, there's been very good progress made the last 12 months. You'll get the $7.7 billion of cash from Solventum. How should investors think about the capital deployment opportunity at 3M post spin, dividends, buybacks? Is M&A likely to stay very low, what, a year or 2 because of the cash-out for the settlement? Any thoughts around that?

Yes. I would start with where I started at the beginning. We had a strong cash generation in '23. And so I think that starts -- we're a strong and reliable cash generator as a company. That's really important. We have a strong balance sheet, strong cash generator. We are, when we received $7.7 billion -- approximately $7.7 billion in proceeds, and we've got the 19.9% stake to monetize over time, too. So it's going to take a strong balance sheet and make it stronger. The strategy behind the spin is to create value for shareholders. The spin of our health care business, Solventum, will create value. And the value they can -- the way they create value is having tailored different strategy for a med tech company. Same for us. We're going to have a capital allocation strategy, and it's going to continue to be first priority, invest in our business. It's going to be returning capital to shareholders, including paying an attractive dividend. And it's going to be being positioned to manage the requirements of the capital for those settlements. Now those settlements, just a reminder, the payments, they're spread over 7 years. Then all the quarters, they're spread over 13 years. So there's a time line to that as well. So I think we're positioning both companies to be successful in tailored capital allocation strategies. .

Got it. And when we think about that cash flow generation of RemainCo, if you like, without Solventum, any sense of kind of how -- what that free cash flow kind of base is dollars or margin rates or conversion rate?

So Solventum is cash flow accretive to 3M, as most med tech companies are. So they have a very strong cash profile. I would tell you, when you look at us and look at 2023, we generated 123% of overall free cash flow conversion, as Mike talked about. The opportunity for us to go forward continues to be driving inventory and accounts payable, working capital. The teams have taken inventory down to 14.8% of sales in '23, but my view is there's still a lot more we can do. The work that the teams have done over the -- through the pandemic on data, data analytic, the ability to visualize where the inventory is, making sure that you're using dual sourcing, you're getting better terms, there's a lot the teams have done, but there's a lot more we can do. So in our view, as I look at margin expansion, which allows us to get cash, plus working capital, and then you invest some of that back in CapEx and R&D, we will continue to be a good cash generator that we have done in the past. And we'll remain, I would say, fiscally prudent on where we invest to make sure we're getting those returns, as Mike said, organically. So overall, I would just say it's -- we see the opportunity that we can get [ especially ] to keep generating cash.

Perfect. And then with that, we'll switch to the audience response for the questions. Firstly, do you own 3M today? So generally, a lot of opportunity there. Number two is around general bias towards 3M at the moment, so very balanced. Third one is around through-cycle earnings growth versus the sort of multi-industry average, slightly below. Fourth question is around excess cash usage, so buybacks and debt reduction. Next is really around valuation, year 1 PE, so sort of high teens. And then the last question is around what's the biggest reason to not own 3M right now. These are standard questions. Okay. So organic growth, leaving aside liabilities. Fantastic. Well, thanks so much, Mike and also Monish.

Thank you.

Thank you.

Thanks very much.