30% Downside For 3M?
3M’s stock (NYSE: MMM) is down 8% so far this year to its current level of $160, but we believe it hasn’t bottomed out yet . Why is that? The key is 3M’s stock was already in a downtrend with a decline of over 25% since 2017, due to its lackluster performance over the recent years. Now with the global economy heading into recession due to the impact of the Covid-19 pandemic, 3M’s business will also face headwinds. Our dashboard, ‘3M Downside: How Low Can 3M Stock Go?‘ provides the key numbers behind our thinking, and we explain more below.
3M’s stock wasn’t doing that well as of the beginning of this year, and it was down over 20% between early 2018 and early 2020, compared to over 20% growth for the broader S&P 500. A significant contributor to this underperformance from the last 2 years was 3M’s P/E ratio, which on a trailing basis, contracted from about 27x at the end of 2017 to 22x at the end of 2019. This can largely be attributed to the company’s disappointing performance over the recent years. The company’s revenues grew a mere 1% between 2017 and 2019, due to soft demand in the automotive and aerospace sectors, along with the impact of divestitures. Modest revenue growth coupled with over a 100 bps decline in the company’s net margins from 15.3% to 14.2% meant a 3% drop in earnings per share between 2017 and 2019.
So What’s The Likely Trigger And Timing To This Downside?
The global spread of coronavirus has meant a rise in unemployment to record levels and a decline in consumer spending power. The industrial output is also declining due to both lower demand, and lower capacity due to social distancing norms. While 3M’s results in Q1 were bolstered by its Healthcare segment, due to the impact of M*Modal and Acelity acquisitions, we believe 3M’s Q2 results in July will confirm the hit to its revenue. It is also likely to accompany a lower Q3 as-well-as full-year 2020 guidance. Specifically, we believe the full-year revenue expectations formed by the market at the time of Q2 results may be closer to $28.6 billion – about 10% lower than its 2017 revenue of $31.7 billion, and 11% lower than the 2019 revenue of $32.1 billion. Our dashboard shows key components of 3M’s revenues.
This could potentially trigger a sell-off, and 3M’s P/E is likely to shrink by about 12% from the current 20.4x to 18x, slightly below the levels of 19x seen in 2017. The 11% reduction in revenues will not accompany a proportional reduction in expenses, as compensation expenses and other fixed costs are likely to fall by a smaller percentage. This will likely result in the net income margin shrinking from 14.2% in 2019 to 12.0% in 2020. This, in turn, would mean a double whammy of roughly 20% lower earnings and 12% lower P/E multiple, translating into 3M’s price drop of over 30%, to about $110 or lower.
Will such a drop be justified? Absolutely not. However, investors who are first out the door in a panic selling situation take a smaller hit to their portfolio. The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard forecasting US COVID-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus.
We do believe these trends are likely to reverse over the next few quarters, and as the coronavirus crisis is tamed, higher revenue and earnings expectations will replace the dire scenarios that are easily imagined during difficult times.
While many companies are focused on making masks in the current crisis, 3M may be a better bet when you compare Honeywell to 3M.
Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture and complements our analyses of the coronavirus outbreak’s impact on a diverse set of companies, including Union Pacific and Adobe. The complete set of coronavirus impact and timing analyses is available here.
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