3M Company (MMM) stock has been falling since the US-China trade war broke out. The stock is down 14.4% YTD (year-to-date), underperforming the SPDR S&P 500 ETF (SPY), which is up 16.6% YTD. 3M stock fell 13% on April 25 after reporting weak first-quarter earnings. Since then, the stock has been in a technical downtrend, trading below its 200-day moving average.
So why is 3M stock falling, and when will it grow? To answer this question, we have to look at the company’s business and its exposure to the trade war.
3M is in the business of safety
3M is a conglomerate that manufactures a range of products related to the safety and hygiene of workers in the healthcare, automotive, transportation, and industrial spaces. It also manufactures adhesives, protection films, and home health and hygiene products. Looking at the nature of 3M’s products, we can see that its revenue is largely in sync with macroeconomic demand—especially industrial and automotive demand.
3M has operations across the globe, but the US and the Asia-Pacific region are its largest markets, from which it earns 40% and 31% of its revenue, respectively. China is its biggest market in the Asia-Pacific region. The company’s high exposure to China and the nation’s industrial and automotive markets, in particular, have put it at a disadvantage.
Correlation between 3M sales and China’s GDP
The trade war slowed China’s GDP growth to a 27-year low in the second quarter. Both US and Chinese manufacturing were depressed in the quarter, as manufacturing output contracted due to reduced trade activity between the two economies. Many companies are shifting their manufacturing outside of China to avoid tariffs.
3M earns the majority of its revenue from its Safety and Industrial segment, which supplies building safety and workforce safety solutions to factories. A reduction in industrial and manufacturing activity in the world’s manufacturing hub, China, has reduced demand for 3M solutions.
Moreover, China’s car sales are plummeting, thereby slowing the global automotive market.
Germany is home to some of the world’s biggest automakers. Germany’s manufacturing PMI plunged to a seven-year low in February, and a slowdown in the automotive industry was one of the reasons. 3M supplies auto electrification solutions to automakers. Slowing demand in 3M’s end markets has impacted its last three quarters’ worth of earnings.
3M’s earnings fall
The US-China trade war started in the fourth quarter of 2018. At that time, 3M had just started reporting YoY (year-over-year) sales declines. While its sales were falling, its net income rose. However, its net income took a hit in the second quarter, falling 30.6% YoY. The company reduced its production output to use its piled-up inventory. It expects its full-year revenue to remain unchanged or rise 1% in 2019.
3M is undergoing restructuring. It’s selling its advanced ballistic-protection business to Avon Rubber for $91 million. The business generates annual revenue of $85 million via the sale of ballistic helmets, body armor, and flat armor to government and law enforcement bodies. 3M is acquiring medical device company Acelity for $6.78 billion. This acquisition will add $1.5 billion to 3M’s annual revenue. These changes will be reflected in 3M’s earnings next year.
How long until 3M stock returns to growth?
If we look at the above fundamentals, we can see that 3M stock is trading at 16.5x its next-12-month EPS, which is higher than the industry average of 15.5x. The next five months will be tough for 3M as the down cycle turns around.
Texas Instruments’ CFO, Rafael Lizardi, said the industry is going through a cyclical downturn. He looked at the last 30 years’ worth of data, which shows different types of cycles. Each is unique and caused by different factors, but they all show one common trend: revenue falls YoY for four to five quarters and then returns to growth. Starting in the first quarter next year, 3M’s revenue could return to growth, as the base year will be the first quarter of 2019, when its revenue was weak.
In the meantime, the 3M stock will continue to fall on any acceleration in the trade war. Investors who already have long positions in the stock will likely want to hold it and enjoy the regular dividends the company pays. Investors who don’t have a position in the stock likely shouldn’t rush to buy at the dip and should instead adopt a watch-and-wait approach.