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QUESTION 1(40 MARKS)

3M Earnings Review: Macroeconomic Challenges and Foreign Currency Headwinds Prevail

Industrial conglomerate3Mreported its fourth quarter and full year 2015 results on Tuesday, with Q4 GAAP earnings of $1.66 per share, a decline of 8.3% over the corresponding quarter of the previous year.Such a significant drop in earnings can be attributed to macroeconomic challenges and volatile foreign currency headwinds, which caused a 5.8 percentage point decline in sales. While net sales fell 5.4% year on year, they surpassed the estimated figures. The corporate restructuring announced by the company in October resulted in a pre-tax charge of $114 million, or $0.14 per share, but will deliver savings of $130 million in 2016.In the last four trailing quarters, 3M has managed to beat earnings thrice.

Weak Demand In Electronics And Energy Segment And Industrial Goods Drives Revenue Lower

A sales decline was seen in all segments in U.S. Dollars, while in organic terms, the Health Care and Consumer divisions reported growth of 4.5% and 2.7%, respectively. A sales decline of 6.3% was reported in the Industrial segment, with foreign currency translations negatively impacting the sales by a massive 6.2 percentage points. Sales growth in 3M purification and automotive OEM was offset by declines in industrial adhesives and tapes, abrasives, and advanced materials. 3M's many products in the Industrials segment exposes it to numerous markets where demand has been deteriorating recently. Electronics related sales were down a massive 8%, as the electronics materials solutions and display materials and systems declined. The consumer electronics segment is impacted by weakness in the consumer electronics end market and excess channel inventory. Nicholas C. Gangestad, CFO and Senior Vice President, expects this softness to continue in the next quarter. With a fall in renewable energy, telecom, and electrical market, energy-related sales dropped 6%.

Corporate Restructuring To Tide Over The Challenging External Environment

3M has been undertaking substantial portfolio restructuring, with efforts being made to divest assets that no longer fit with its corporate strategy and investing in ones which are more in tune with it. During the quarter, 3M sold its Library Systems business across the globe. Since 2012, the company has cut its businesses from 40 to 26, and invested substantially in R&D to develop innovative products. Moreover, a new global ERP system is being introduced to standardize its business processes. Such efforts should result in significant annual operational savings and reduce the working capital. Despite such initiatives, 3M has been adversely affected by weak macroeconomic conditions and unfavorable movement in foreign currency exchange rates.

The company managed to increase its margins 60 basis points to a healthy 22.1%, excluding restructuring, with four of the five businesses posting margins over 21%. Lower raw material costs and higher selling prices were the primary drivers for this, contributing 2% to margin expansion, with global sourcing teams capitalizing on lower commodity prices. Foreign currency, net of hedge gains, eroded margins by 30 basis points. Given the low growth environment, 3M's ability to increase the margins has been quite impressive. The foreign currency headwinds warrant a need for financial hedging. 3M hedges close to 50% of its economic exposure on a rolling 12-month basis and also has additional hedges as far as 36 months in some of the liquid currencies. For 2015, this resulted in a benefit of $182 million.

3M continues to invest heavily in R&D, acquisitions, and CapEx. Of the $7 billion investment in these, $1.18 billion was in R&D, helping the company to invent and manufacture cutting-edge, relevant, and unique products. Such investments should aid in curtailing the negative effects of the weak global environment.

Potential Upside and Downside To Trefis Price

1. Safety & Industrial constitutes 37% of the Trefis price estimate for 3M's stock.
2. Healthcare constitutes 28% of the Trefis price estimate for 3M's stock.
3. Transport & Electronics constitute 22% of the Trefis price estimate for 3M's stock.

WHAT HAS CHANGED?

1.Impact of Coronavirus On 3M's Stock

3M stock lost more than 34% - dropping from $180 at the beginning of 2020 to below $119 in late March 2020 - then spiked 65% to around $197 now (through Apr 30, 2021). That means it has partially recovered to the pre-pandemic levels.

Why? While the Covid-19 outbreak and associated lockdowns resulted in an uncertain outlook for the broader markets, the multi-billion-dollar Fed stimulus announced in late March 2020 helped the markets stage a strong

recovery. Further, with economies opening up gradually, demand for 3M's products and services will likely pick up. In addition, the company posted better than expected results over the recent quarters, boding well for MMM stock.

2.Q1 2021 Earnings

3M reported 9.6% revenue growth from $8.9 billion in Q1 2021, compared to $8.1 billion in Q1 2020. While all four segments saw positive growth during the quarter, Safety & Industrial revenues saw highest growth, up 14% y-o-y. Looking at 3M's bottom line, Adjusted EPS grew 26% to $2.77, compared to $2.19 in the prior year quarter.

3.3M Completes Acelity Acquisition

3M completed the acquisition of Acelity for a total enterprise value of $6.7 billion through debt and available cash. Acelity is a medical technology company that provides advanced wound care and specialty surgical applications under the Kinetic Concepts (KCI) and Systagenix brands. Acelity and its KCI subsidiaries will be integrated with 3M's medical solutions business, under the Healthcare segment. Notably, 3M paid $6.7 billion to acquire Acelity at a EV/EBITDA multiple of 11x.

4.3M suspends operations at Venezuela subsidiary

3M suspended its local operations in Venezuela for the foreseeable future, citing market turmoil and lower demand in the South American nation. 3M said that "in light of continuing challenging circumstances in Venezuela, including its unstable environment and heightened unrest that have led to a sustained lack of demand" in the Venezuela market. Venezuela's economy has largely collapsed in the past year.

5.Strategy of Portfolio Management

o3M has been very active on the M&A front in recent years, having made significant acquisitions such as Scott Safety, Capital Safety, Polypore's Separations Media business, and Ivera. The company has also made an effort to slim down. Some of the big-ticket sales include that of its Static Control and Library Systems businesses, and Faab Fabricauto.

oSince 2012, 3M has gone from six sectors to four business groups, and has pruned its businesses or divisions from 40 to 28, thereby improving customer relevance, productivity, and speed, through a leaner operating structure.

o3M was quite active on the M&A front in 2019, and undertook a number of divestitures in its Transportation Safety division with an intent of improving its portfolio. This included the sale of its Identity Management business, Tolling and Automated License/Number Plate Recognition business, and its Electronic Monitoring Business. Acquisitions, net of divestitures, increased sales by 5.1 percent.

1. China to Power Growth in the Future

o3M has had a presence in China since 1984 when it was the first wholly-owned foreign enterprise that was set up outside the Shenzhen economic zone. The company has grown to over $3 billion in sales from the region, and continues to see the country as an attractive growth opportunity. 3M has a solid footing in the country as a result of its base in the infrastructure and manufacturing business. Improvements in the safety, healthcare, and retail businesses in China have helped to spur the growth of these businesses of 3M as well, which currently represent over $1 billion of its $3 billion China portfolio. The company has been able to achieve this by using scale to drive growth in its domestic-oriented business that can ensure sustainable growth even in the future. Given the possibility of a trade war with China, one factor that may work in 3M's favor is that the company has focused on local manufacturing, in the sense that it manufactures within China for its Chinese customers. Consequently, the impact of the steel and aluminum tariffs are expected to be minimal.

BUSINESS SUMMARY

3M is a diversified technology company with a global presence in the following businesses: Safety & Industrial; Transportation and Electronics; Health Care; and Consumer. 3M is among the leading manufacturers of products for many of the markets it serves. Most of its products involve expertise in product development, manufacturing and marketing, and are subject to competition from products manufactured and sold by other technologically oriented companies. Some of the company's most recognizable brands include Scotch Tape products, Post-It notes, ACE bandages, and Thinsulate insulation products. 3M is widely considered one of the most innovative companies in the world, with a third of the company's sales come from products which have been launched in the prior five years. The company has benefited from its global footprint, with 60% of its sales coming from international markets.

SOURCES OF VALUE

We estimate that the Safety & Industrial business constitutes around 36% of 3M's value, while the Health Care constitutes of 29%, Transport & Electronics 21% and Consumer divisions contribute 14%. The following factors are also helping to drive the company's value.

CONSISTENT INNOVATION AND AGGRESSIVE ACQUISITIONS DRIVE INDUSTRIAL MARKET SHARE

The company's heavy R&D focus has resulted in innovative and unique products. We expect that the company's focus on high-growth areas, like renewable energy and bioplastics, will allow the company to maintain its market share in the face of increasing international competition. 3M will also benefit from an increased demand from automotive, aerospace, and industrial adhesives and tapes customers, with its growth driven by Asia-Pacific.

MAINTAINING HIGH MARGINS IN THE HEALTHCARE SEGMENT IS PARAMOUNT

3M's Healthcare margins typically range around 35-40%, while those for other divisions are mostly around 25-30%. This is what allows the Healthcare business to contribute such a meaningful percentage of 3M's value. Margins in this business are so high because of the uniqueness of 3M's products and patent protection. Accordingly, the company must continue to be innovative in producing new (patent-protected) products and in protecting its existing patent portfolio.

Source:

https://www.forbes.com/sites/greatspeculations/2016/01/28/3m-earnings-review-macroeconomic-challenges-and-foreign-currency-headwinds-prevail/?sh=a114e1230700

Required:

a)How 3M affected by exchange rate changes from the above case?(6 marks)

b)Distinguish between 3M transaction exposure, economic exposure and translation exposure (if any).(8 marks)

c)How 3M protect itself against the THREE (3) exposures as above?(8 marks)

d)What financial, marketing and production techniques can 3M use to protect itself against economic exposure.(8 marks)

e)Is the restructuring given benefits to 3M? Assess and interpret your answer.

(10 marks