Co-founder of Dropbox, Drew Houston, once claimed that what entrepreneurs need “is a blind optimism and a tolerance for uncertainty.” To a certain degree, so do the 3M investors. On January 29 earnings call, 3M CEO, Mike Roman, said that 3M widens its organic growth expectation for 2019 from 2-4% to 1-4%. The guidance comes in the wake of a not so impressive 2018. 3M had the largest decline of operating income in a decade, company missed R&D to sales target of 6%, and its SG&A expense increased almost by $1 billion.

The volume of organic sales dropped sharply in Asia-Pacific and was flat in Europe, Middle East and Africa. 3M blamed improved air quality in China for decline in organic sales in Asia-Pacific. Consumer segment in the region indeed had a negative growth rate of 3%.

Air pollution in China is a problem of such magnitude that Chinese government has declared war on it. As can be seen from the 11.5% spike in organic volume sales in Asia-Pacific in 2017, 3M benefited greatly from the popularity of its face masks in China. While the Chinese government claims that significant progress has been made in combating air pollution in 2018, China’s official statistics are notoriously unreliable. An important question going forward, however, is how much headwind 3M will face from other factors: slowing down of the Chinese economy, trade tensions with the United States, China’s continuing investment in domestic high-tech manufacturing. While a successful rollout of the new ERP system in the region may improve the situation, we expect 3M’s 2019 organic sales in Asia-Pacific to be closer to the low end of 1-5% range.

In contrast to Asia-Pacific, the lack of growth in EMEA region was somewhat expected given that last year 3M sold its Communication Markets Division to Corning. The breakdown of organic sales in Electronics and Energy segment shows that out of all regions, only EMEA had a negative growth rate, while organic sales in the United States grew 4.6%, Asia-Pacific - 3.9%, and Latin America/Canada - 2.5%. The divestiture has also contributed to the slump in organic sales growth in the overall Electronics and Energy segment: 3.3% - a 7.7% decline comparing to 2017. Portfolio optimization, acquisitions and divestitures at a frantic pace that is, has also played a part in a 3.9% negative growth rate of organic sales in Consumer segment in EMEA region. However, as the effects of portfolio reshuffling are wearing off, we expect 2019 organic sales in the region to improve and to be closer to the high end of 1-3% range.

Compared with Electronics and Energy, the decrease in Health Care is more modest: a 2.6% growth comparing to 3.9% in 2017. Yet, it’s the lowest organic sales growth rate in this segment for the last 5 years, partially due to diminished drug delivery sales in 2018. On Q3 earnings call, 3M cited the “pharmaceutical regulatory timelines and customer R&D budgets” as a reason for the slump in drug delivery sales. 3M’s contract manufacturing model makes it hard to predict how the situation will develop in 2019. In addition, more paperwork and longer review periods under FDA’s newly adopted Medical Device Safety Action Plan may represent a substantial regulatory hurdle. However, improvements in other Health Care sub-segments in 2019 should be more than enough to offset uncertainty about drug delivery systems. In particular, we expect further increases in Health Information Systems sub-segment in the wake of 3M’s $1 billion acquisition of AI-powered platform M*Modal. Overall, 3M’s forecast that Health Care segment will lead organic sales in 2019 seems reasonable.

3M is an outstanding company that provides a lot of reasons to be optimistic about its future. The company has a broad portfolio of products, a global presence, and has paid dividends since 1916. At the same time, 3M is overexposed to systemic risks associated with the world economy, susceptible to foreign currency fluctuations, and has a lofty valuation. Recommended Strategy: Hold.