3M’s Print Disappointing; Lowering FVE to $187

Wide-moat-rated 3M MMM came up short relative to what we originally earmarked in the third quarter. We lower our fair value estimate to $187 from $195 previously. The driver of the fair value decrease was our midcycle margin assumption, primarily due to 3M’s safety and industrial segment, but also due to margin headwinds in its transportation and electronics segment. Management certainly struck an optimistic tone on the company’s long-term trajectory and its ability to deliver strong growth, margins, and cash conversion, and that the firm will eventually get past these headwinds.

We broadly agree with this view. Nevertheless, we can’t ignore the dynamics in the short term and what the current math implies for the company’s long-term trajectory. While we still agree that 3M can generate 30% to 40% incremental margins over the long run (though we remain below the midpoint of this range), that implies a lower midcycle margin than we suspect is currently baked into analysts’ implied valuations.

To be fair, however, management did warn the market of severe raw material inflation to the tune of 100 to 150 basis points in price-cost headwinds (which was relayed since our last update following second-quarter results). It also flagged that it would be at the upper end of this range, while also quoting 65 to 80 cents of full-year EPS headwinds.

True to form, based on our rough math, price-cost headwinds were a hair over 130 basis points, despite 3M taking 140 basis-points’ worth of price year on year. That’s not a common occurrence in 3M’s historical experience since the current analyst has covered the stock. Third-quarter sales did come in nearly $200 million better than our expectations (at nearly $35.5 billion realized, an increase of 7.1% year on year, or 6.3% on an organic basis, versus $35.3 billion expected), which was encouraging.

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