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Here's Why You Should Hold on to Kennametal (KMT) Stock

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We have issued an updated research report on Kennametal Inc. (KMT - Free Report) on Sep 11. Though the company is poised to gain from its diversified business structure, cost-reduction efforts and shareholder-friendly policies, we believe that exposure to forex woes, industry competition and high debt levels might restrict its growth momentum in the quarters ahead.

It currently carries a Zacks Rank #3 (Hold). Over the last 60 days, the stock’s Zacks Consensus Estimate increased 2.3% to $2.20 per share for fiscal 2018 while decreased 5.4% to $2.65 for fiscal 2019.

Below we discuss why investors should now hold Kennametal’s stock.

Growth Drivers

Diversification Benefits: We believe Kennametal is poised to benefit from its diversified customer base in the aerospace, automotive, machine tool and farm machinery industries as well as manufacturers and suppliers in the highway construction, coal mining, quarrying, and oil and gas exploration industries. Its product portfolio includes cemented tungsten carbides, super alloys, and coatings and castings, among others.

Furthermore, international diversity has played a major role in Kennametal’s profitability over time. Notably, in fourth-quarter fiscal 2017 (ended Jun 30, 2017), it derived nearly 47.7% of net revenues from its North American operations while roughly 52.3% were sourced from Western Europe and Rest of the World.

Strategic Initiatives: Kennametal has taken certain measures to develop a sound cost structure. By December 2018, the company anticipates its restructuring programs, including headcount reduction initiatives and others to yield pre-tax savings of approximately $165-$180 million. Of these programs, the company predicts its headcount reduction initiatives to result in estimated annualized savings of $90 million by December 2017 while other programs are likely to generate savings of $75-$90 million by December 2018. Also, the company remains keen on making meaningful acquisitions and disposing non-core assets. We believe such strategic moves will help it manage its portfolio as well as enhance business activities.

Shareholders’ Return and Promising Fiscal 2018 Guidance & Long-Term Targets: Share buybacks and dividend payments are the prime means of returning value to shareholders for Kennametal. In fiscal 2017, the company paid cash dividends of $64.1 million to its shareholders.

For fiscal 2018, the company anticipates adjusted earnings to be within $2-$2.30 per share range, above $1.52 recorded in fiscal 2017. The bottom line is likely to benefit from organic sales growth of 2-4% and cost-reduction initiatives.

Over the long term (2017-2019), Kennametal anticipates total revenues to witness a compound annual growth rate (CAGR) of 2-3%. Earnings before interest and tax margin are predicted to improve 400-500 basis points (bps) while earnings per share are expected to record a CAGR of above 20%. Free cash flow is anticipated to be greater than 10% of sales and return on invested capital is predicted to improve 400-500 bps.

Headwinds Restricting Kennametal’s Growth Prospects

Poor Share Price Performance and Valuation: Over the last three months, Kennametal’s shares have lost nearly 13%, underperforming 0.1% gain recorded by the industry. Also, on a P/E (TTM) basis, the company looks overvalued compared with the industry with respective tallies of 24x and 22.9x in the last three-month period. This makes us cautious on the stock.

Diversification Woes: We believe Kennametal’s geographical expansion has exposed it to risks arising from foreign currency movements and geopolitical issues. Notably, the company’s fourth-quarter fiscal 2017 revenues were adversely impacted by 2% negative impact from foreign currency translation. We believe that uncertainties in the economic growth of the countries served or weakness in industrial activities in the quarters ahead might severely impact its businesses.

Rising Debt Levels and Others: Kennametal faces risks from high debt levels. Exiting fourth-quarter fiscal 2017, its long-term debt and capital leases was roughly $695 million. We believe that a rise in the debt level, if unchecked, will increase the company’s financial obligations and hence hurt profitability.

In addition, the company secures a major portion of its raw materials from non-U.S. countries, thus raising concerns over its availability and price fluctuations. Also, it encounters active competition in all of its businesses from both larger and smaller companies that offer the same or similar products and services, or those producing different products appropriate for the same use.

Zacks Rank & Other Stocks to Consider

Kennametal currently has $2.9 billion market capitalization. We believe that the above-mentioned positives and negatives clearly justify the stock’s current Zacks Rank #3.

In the machinery space, some stocks worth considering include Kadant Inc. (KAI - Free Report) , Sun Hydraulics Corporation (SNHY - Free Report) and Barnes Group, Inc. (B - Free Report) . While both Kadant and Sun Hydraulics sport a Zacks Rank #1 (Strong Buy), Barnes Group carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Kadant’s earnings estimates for 2017 and 2018 were revised upward in the last 60 days. Also, the company delivered an average positive earnings surprise of 19.29% in the last four quarters.

Sun Hydraulics pulled off an average positive earnings surprise of 3.47% for the last four quarters. Also, its earnings estimates for 2017 and 2018 improved in the last 60 days.

Barnes Group’s earnings estimates for 2017 and 2018 were revised upward in the last 60 days. Also, the company’s average earnings surprise for the last four quarters was a positive 11.60%.

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