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Growth & Income

Kennametal Inc. (KMT - Analyst Report) recently delivered record EPS for the first quarter, driven by strong organic sales growth and operating leverage. It was also the company's 10th consecutive positive earnings surprise.

Management raised its EPS guidance for 2012, prompting analysts to revise their estimates higher. It is a Zacks #2 Rank (Buy) stock.

In addition to strong growth, Kennametal pays a dividend that yields a solid 1.6%. And the company recently raised its quarterly payout by 17%, marking the first dividend increase in 4 years.

Valuation looks very reasonable with shares sporting a PEG ratio of just 0.7.

Company Description

Kennametal produces metal-cutting tools and tooling systems for metalworking manufacturers and suppliers across a wide range of industries. It operates through two segments:

Industrial: 63% of sales
Infrastructure: 37%

The company was founded in 1938 and is headquartered in Latrobe, Pennsylvania.

Third Quarter Results

Kennametal reported record results for the first quarter of its fiscal 2012. Earnings per share came in at 88 cents, beating the Zacks Consensus Estimate of 78 cents. It was a remarkable 87% increase over the same quarter in 2010.

Revenue soared 25% to $659 million, ahead of the Zacks Consensus Estimate of $618 million. This was primarily driven by a stellar 17% increase in organic revenue growth.

Sales were strong at both segments. The Industrial division saw organic top-line growth of 17%, led by a 22% increase in general engineering and a 14% increase in transportation. The Infrastructure division also experienced organic growth of 17%, driven by 19% growth in energy and related products and a 14% increase in earthworks products.

Higher raw material costs were more than offset by the leveraging of its fixed expenses. This led to significant operating margin expansion - from 11.7% to a record 15.4%.

Outlook

Management raised its EPS guidance for 2012 following strong first quarter results. The company stated that "global economic conditions and worldwide industrial production are expected to continue to reflect moderate expansion."

Management now expects EPS in the range of $3.60-$3.85, up from previous guidance of $3.50-$3.80. This prompted analysts to revise their estimates higher, sending the stock to a Zacks #2 Rank (Buy).

Based on consensus estimates, analysts project strong growth to continue for Kennametal over the next couple of years. The Zacks Consensus Estimate for 2012 is $3.67, within guidance, and representing 23% growth over 2011 EPS. The 2013 consensus estimate is currently $4.11, corresponding with 12% EPS growth.

Dividend

In addition to strong growth, Kennametal offers a dividend that yields 1.6%. And the company recently raised its quarterly dividend by 17% - its first increase since 2007. This is a good sign that management feels confident in the outlook of the business.

Valuation

Despite strong fundamentals, shares of KMT have been held back by macroeconomic concerns. As long as there is not a significant slowdown in the global economy next year, valuation looks compelling.

Shares trade at just 9.3x 12-month forward earnings, a discount to its 10-year median of 13.8x. Based on a 5-year EPS growth of 14.1%, its PEG ratio is an attractive 0.7.

The Bottom Line

With strong growth projections, rising earnings estimates, a 1.6% dividend yield and attractive valuation, Kennametal offers a lot of upside potential.

Todd Bunton is the Growth & Income Stock Strategist for Zacks Investment Research and Co-Editor of the Reitmeister Value Investor.

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