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Kennametal Inc. (KMT - Analyst Report) recently delivered record EPS for the second quarter, driven by continued strong organic sales growth and operating leverage. It was also the company's 11th consecutive positive earnings surprise.

Management once again raised its EPS guidance for 2012, prompting analysts to revise their estimates higher. It is a Zacks #1 Rank (Strong Buy) stock.

Despite a strong up in shares over the last few weeks, valuation looks very reasonable with shares trading at just 11.2x 12-month forward earnings. It is also sporting an attractive 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: 64% of sales
Infrastructure: 36%

The company was founded in 1938 and is headquartered in Latrobe, Pennsylvania. It has a market cap of $3.7 billion.

Fourth Quarter Results

Kennametal reported record results for the second quarter of its fiscal 2012. Earnings per share came in at 91 cents, beating the Zacks Consensus Estimate of 79 cents. It was a remarkable 60% increase over the same quarter in 2011.

Revenue soared 13% to $642 million, ahead of the Zacks Consensus Estimate of $640 million. This was primarily driven by a stellar 14% increase in organic revenue growth.

Sales were strong at both segments. The Industrial division saw top-line growth of 11%, led by a 12% increase in general engineering and a 16% increase in aerospace & defense. The Infrastructure division experienced organic growth of 18%, driven by 25% growth in energy and related products and a 15% increase in earthworks products.

Despite rising input costs, gross profit actually expanded from 35.4% to 36.1% of sales. This, along with leveraging of fixed expenses, led to a whopping 45% increase in operating income.

Outlook

Management once again raised its EPS guidance for 2012. The company reiterated its statement that "global economic conditions and worldwide industrial production are expected to continue to reflect moderate expansion."

Management now expects EPS in the range of $3.70 to $3.90, up from previous guidance of $3.60-$3.85. This prompted analysts to revise their estimates higher, sending the stock to a Zacks #1 Rank (Strong 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 $3.83, within guidance, and representing 28% growth over 2011 EPS. The 2013 consensus estimate is currently $4.30, corresponding with 12% EPS growth.

Valuation

Despite shares climbing 32% since December 19, valuation still looks attractive for KMT. As long as there is not a significant slowdown in the global economy this year, shares look like they still have plenty of room to run higher.

Shares trade at just 11.2x 12-month forward earnings, a discount to its 10-year median of 13.8x. Based on a 5-year EPS growth of 17.4%, its PEG ratio is an attractive 0.7.

Its price to book ratio of 2.3 is in-line with the industry and well within value criteria. It also trades at just 9.6x cash flow, which is very attractive considering its growth outlook.

The Bottom Line

With strong growth projections, rising earnings estimates, 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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