It's difficult to say because there really isn't a macro-related catalyst that is driving the market higher. But one possible explanation is simply that these fears and concerns about a global economic slowdown have already been baked in and digested by investors, setting a low bar for companies to hurdle. When a highly diversified company like MMM beats quarterly expectations and offers guidance and commentary indicating that the sky isn't falling, that translates into a "better-than-feared" reaction from investors.
To be sure, MMM's results and outlook were nothing to write home about. But, as we discuss below, it does seem clear that business conditions in China are relatively stable and that some of the margin pressure resulting from rising raw material costs is being absorbed by higher prices. Combine that with MMM's earnings and cash flow growth, along with its dividend (yielding 2.8%), and there is enough to this stock for investors to cling on to.
Closer Look at Q4
MMM posted EPS of $2.31 (+10%), modestly beating analysts' $2.28 expectation, with revenue down -0.6% to $7.9 bln, virtually in-line with consensus. On an organic local-currency basis, sales were up 3%, with MMM seeing growth across all of its business groups and geographic areas. In a reversal from last quarter, it was the Healthcare business that led, up 5% organically with notable strength in the China/Hong Kong market at +18%.
The company also generated very healthy cash flow from operations, up 23% year/year to $1.7 bln. However, operating income was flat year/year and operating margin dipped a bit to 22.4% from 22.8% in the year ago period. Last quarter, operating margins declined in all of the company’s segments with the exception of Electronics and Energy. Furthermore, during its Q3 earnings call, management had stated that it expected raw material price increases but that pricing should offset those increases.
That indeed proved to be the case, as higher selling prices contributed 20 basis points to Q4 margins. Lower year/year divestiture gains did knock margins lower by 120 basis points, but MMM has been able to successfully pass higher costs through, helping to alleviate one main concern.
In terms of business segments, the standout performer was the Healthcare business, bouncing back impressively from a sub-par Q3 in which sales fell by 1.1% organically. The segment suffered from weakness in its drug delivery business, which is dependent upon pharmaceutical regulatory timelines and customer R&D budgets. Specifically, that business experienced a sharp 25% drop in growth last quarter.
This time around, its medical solutions business drove the turnaround as products within the vascular access and securement solutions category saw particular strength. As noted above, the Chinese market was especially (and surprisingly) strong. However, there are a couple caveats here. First, during the earnings call, MMM commented that it still expects some lumpiness in drug delivery -- although for the full year, the impact should be negligible.
Second, management was still pretty cautious about China overall, saying that there has been slowing in some key markets, with the biggest impacts coming from a declining auto market. On that note, MMM's automotive OEM business was down 1% year/year. The good news is that the company outperformed global car and light truck builds by 400 basis points. Generally speaking, though, the auto vertical has been a common theme this earnings season, as we have heard similar commentary regarding the Chinese auto market from companies like Sherwin-Williams (SHW) and Ferro (FOE).
Lastly, one of the primary reasons why MMM ratcheted its FY19 organic growth guidance down to 1-4% from 2-4% is due to the slowing Chinese economy, in addition to softness in the electronics industry.
Outlook & Conclusion
In its earnings press release, MMM lowered its FY19 EPS guidance to $10.45-$10.90 from its prior expectation of $10.60-$11.05. Still, at the mid-point ($10.68), its outlook is basically in-line with the $10.70 consensus. From a geographic perspective, MMM expects organic growth of 2-4% in North America, 1-3% in EMEA, 1-5% in APAC, and 3-5% in Latin America and Canada.
In 2019, the company will continue to re-shape its product portfolio, focusing on higher margin areas such as energy and health care solutions. As some may recall, MMM closed the sale of its communications division to Corning for $870 mln during the past year. This portfolio shaping strategy was also illustrated when it acquired M*Modal last month, which is a provider of AI powered healthcare solutions.
In addition to its growth initiatives, returning capital to shareholders through buybacks and its dividend will remain a priority.
To conclude, while MMM certainly didn't "knock it out of the park", its results and guidance indicate that conditions remain relatively stable. Its lowered outlook wasn't a massive cut, but rather a "revision down", as MMM described it, driven by China and a slowing in the outlook for build rates in the auto industry.