The reports that followed 3M Co.’s disappointing recent earnings announcement made clear how analysts interpreted CEO Mike Roman’s statement that “operational execution fell short of the expectations we have for ourselves.”
Put simply, 3M executives had admitted to being too slow to do what investors saw as the right thing — letting a lot of 3M employees go.
The company said it was going to reduce head count by about 2,000, roughly 2% of the workforce, through what its executives called “voluntary and involuntary” actions. People with experience at big companies know voluntary likely means some sort of early retirement benefits for agreeing to leave, and everyone knows what involuntary means.
All of this illustrates the kind of pressure managers of even a widely admired company like 3M are under. One of the reasons 3M enjoys its lofty status is its tradition of planning for the long term, particularly its commitment to continually putting a lot of money into coming up with new products and technologies.
Here its executives thought they had to all but apologize for having not already laid people off.
It’s not that Maplewood-based 3M didn’t make a lot of money in the first quarter, by the way. It generated an operating margin of better than 21%, once adjusted for costs of lawsuits. But sales of not quite $7.9 billion were down about 5% from the same period of 2018. And that made the quarter not profitable enough.
Analysts called these financial results “rough,” “unsettling” and even “disastrous.” 3M took down the Dow Jones industrial average that day nearly 200 points.
Investors really care about what happens to 3M, one of the 30 stocks that make up the Dow average. One reason is because of the kind of company it is, called a short-cycle industrial company.
A long-cycle company is one that has a backlog of orders that will take a while to ship or otherwise get recognized as revenue. A big and growing backlog of orders can be really comforting to investors, looking ahead to a coming year’s earnings. Honeywell, a company in the same industrial club as 3M, reported a backlog of almost $25 billion as of the end of last year, with only a little over half of that to be recognized as revenue in 2019.
On the other hand, 3M’s products are generally ordered, built, shipped and then used by the customers pretty much right away. Customers don’t order Scotch tape now for delivery in December because it doesn’t take 3M six months from start to finish to make and ship it.
Another feature of companies like 3M is that the products are often stocked, maybe in a room off the shop floor or in a warehouse. And when production slows for customers using products and materials made by 3M, they don’t just slow down orders to adjust to a new production schedule. They also try to work off some inventory, and that can mean slashing orders. This happens at distributors, too.
As a result, 3M’s sales tend to act a little bit like an early warning indicator for the broader industrial economy.
3M executives tried not to give investors too much cause for worry, saying that 3M had problems of its own making responding to some specific market weakness. The sluggish sales problem for 3M in its first quarter got attributed mostly to automotive products, electronics and sales in China. Sales in the automotive and aerospace markets, a big part of 3M’s business, declined about 10%.
Given all this, the output of 3M’s plants slipped about 4% to 5% in the first quarter, as explained on the follow-up conference call with investors. This drop in production volume wouldn’t have affected profits much if 3M had also managed to cut spending at the factory level by the same amount. Instead, spending only declined 1%.
It’s not always easy to tell, of course, whether a blip in sales is a bad week or the start of a bad quarter. And even if it looks like sales are slipping, there’s no practical way for managers to cut costs quickly for a lot of things, including depreciation on all the equipment in a plant.
But they can control how many people come to work and collect a paycheck.
The 2,000 jobs the company said would be eliminated come from across the company, but with a bigger impact on its corporate structure and on the business groups that aren’t performing well.
After booking some costs related to the restructuring, 3M is looking to save maybe $225 million to $250 million annually. That’s less than 1% of what 3M is expected to book this year in total costs of making products and operating the company.
The analysts who follow 3M sounded unforgiving about how slowly 3M reacted to slowing sales.
“And I don’t mean this to be mean, but if you go back … about the 20 years or so I’ve covered your stock, 3M always seems to be a little bit behind on the restructuring curve, almost never ahead,” said analyst Scott Davis of Melius Research, setting up a question to Roman on the conference call. “And even if you get this one right, you’re still behind.”
His question for Roman turned out to be on the wisdom of changing executive pay to reward managers for cutting costs faster. Roman responded with a noncommittal answer that 3M always looks to tweak its practices.
Obviously Roman couldn’t agree, presiding over a company with a reputation for innovation and long-term thinking, to paying some kind of bonus to the first business unit manager each quarter who cuts staff.
And, hopefully out of earshot of investors, he suggested it might be OK for 3M to be known for being slow to lay people off.