3M's Turnaround Is Off to a Good Start. Here's Why It's a Buy for 2025 and Beyond.

3M (NYSE: MMM) recently updated the market with its fourth-quarter earnings report, and management's comments essentially confirmed the bullish case for the stock. While its end markets remain mixed and its top-line growth rate muted, the company is progressing well in expanding margins and laying down the fundamentals for future growth. This combination makes the stock a compelling buy for 2025.

3M's medium-term aims

Before getting into the details, it's worth noting that 3M has an investor day planned for Feb. 26. At this event, CEO Bill Brown (appointed May 2024) will lay out its medium-term vision and objectives.

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While it makes sense to start inking in expectations after management outlines its guidance, there's plenty to go on for investors penciling in assumptions, most of it positive. Here are some clues from management's high-level commentary:

• Brown is aiming to take 3M's gross profit margin to the "high 40s" compared to 41.2% in 2024 and 39.1% in 2023, partly by cutting the cost of goods sold (COGS) by 2% a year through productivity measures
• Cutting the number of days a year it holds inventory before selling it to 75 days compared to 94 days in 2024 and 96 in 2023 -- freeing up about $1 billion in cash, which could be returned to investors
• Improving 3M's long-term growth rate by rejuvenating its research and development (R&D) operations to develop new product introductions (NPI)

Consider the table below for some back-of-the-envelope calculations. It assumes 3M can grow sales at a low single-digit rate (3%, in line with GDP growth) for the next five years and gross margins to 48% ("high 40s"). Furthermore, given that Brown is trying to reduce sales, general, and administrative costs (SG&A) and increase its focus on R&D, it's reasonable to assume a slight uptick in overall SG&A plus R&D margins.

Note that these are conservative assumptions purely for indicative purposes. However, if a stock price rise matches the 53% increase in operating income, investors can expect a 9% annual return over the next five years. Throw in a 2% dividend yield, and it's roughly 11%. Include some valuation expansion (highly likely if 3M achieves its objectives), and 3M investors could look at mid-teens annual returns over the next five years.

Data source: 3M presentations, *author's analysis. Bp is basis points, where 100bp=1%.

3M risks

While the scenario painted above is rosy, it has some risks. For starters, 3M's end markets aren't helping much. Management is calling for 2% to 3% organic revenue growth in 2025. Moreover, auto builds (a key end market for 3M) are expected to decline in the U.S. and Europe (where 3M has more exposure) this year and be flat in China. Moreover, relatively high interest rates continue to curtail consumer discretionary spending -- not good news for 3M's range of consumer home and auto products.

Moreover, 3M's growth rate has been mediocre for some time, and there's no guarantee it will improve on it or successfully develop higher-margin NPIs to drive sales growth.

Image source: Getty Images.

3M opportunities

That said, there's plenty of room for improvement at 3M, and Brown cited improvements in the number of days it holds inventory (as discussed in the bullet points above), improvements in on-time in-full (OTIF) deliveries to 88% compared to 85% in 2023. 3M's ongoing restructuring actions (initiated by former CEO Mike Roman in 2023) are largely complete and helped improve its operating margin to 21.4% in 2024 from 18.6% in 2023. While these appear to be granular-level details, they are the clockwork that makes the margin mechanism work.

Moreover, management's guidance calls for further operating margin improvement to 22.7%-23.3% in 2025, giving confidence that 3M is on the medium-term track to margin improvement.

Image source: Getty Images.

A stock to buy?

Cautious investors may want to wait until 3M's investor day in February before considering buying, but otherwise, 3M looks like an attractive stock. Management is demonstrating initial progress in its initiatives, and there's plenty of room for improvement in its operations and financials.

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends 3M. The Motley Fool has a disclosure policy.