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Kennametal (KMT) Gains From Tactic Initiatives, Costs Drag

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We have issued an updated research report on Kennametal Inc. (KMT - Free Report) on Apr 12.

The industrial tool maker, with a market capitalization of $3.3 billion, currently carries a Zacks Rank #3 (Hold).

Certain growth drivers and headwinds that might influence Kennametal have been discussed below.

Factors Favoring Kennametal

Share Price Performance, Impressive Earnings Outlook: Kennametal impressed shareholders with an earnings beat of 2.90% in second-quarter fiscal 2019 (ended Dec 30, 2018). This was the third consecutive quarter of an earnings beat. Average earnings surprise for the last four quarters was a positive 3.15%.

In the past three months, the company’s shares have increased 13%, above the industry’s growth of 10.9%.




The company anticipates gaining from initiatives (including growth, modernization and simplification) and strengthening end-markets. For fiscal 2019 (ending June 2019), adjusted earnings are anticipated to be $2.90-$3.20 per share, above $2.65 recorded in fiscal 2018 (ended Jun 2018).

Currently, the Zacks Consensus Estimate for earnings is pegged at $3.13 for fiscal 2019 and $3.49 for fiscal 2020, reflecting year-over-year growth of 18.1% and 11.4%, respectively.

Kennametal Inc. Price and Consensus

 

Kennametal Inc. Price and Consensus | Kennametal Inc. Quote

Tactical Initiatives: Kennametal has undertaken various restructuring initiatives over time. Its head-count reduction and other miscellaneous programs, completed in the first quarter of fiscal 2018 (ended September 2018), yielded roughly $3 million in pre-tax savings in the second quarter of fiscal 2019 and approximately $12 million in the first half of fiscal 2019.

In addition, the company’s three initiatives — including growth, modernization and simplification — are proving beneficial. While growth initiative is boosting sales through improvement in commercial execution, the simplification initiative helped in improving operational efficiency and lowering costs. The modernization initiative is currently in progress and is contributing to strong operating leverage. Notably, these initiatives boosted the company’s bottom line by 10 cents in second-quarter fiscal 2019.

Long-Term Prospects: Diversified customer base and solid footprint in various end markets — including aerospace, automotive, machine tool, farm machinery, highway construction, coal mining, quarrying, and oil and gas exploration industries — remain beneficial for Kennametal in the long run. Also, its above-mentioned initiatives are boons.

By fiscal 2021 (ending June 2021), the company anticipates adjusted sales of $2,500-$2,600 million. It expects the Industrial segment's sales to increase 2-4% (CAGR). Sales growth of WIDIA and Infrastructure segments are projected to be 9-11% and 3-5%, respectively.

Adjusted gross margin is estimated to be approximately 41% and adjusted operating expenses are predicted to be roughly 20% of sales. Adjusted earnings before interest, tax, depreciation and amortization (EBITDA) will likely be $600-$675 million and EBITDA margin will be 24-26%. Adjusted operating margin is expected to be 19-21%.

Factors Working Against Kennametal

Higher Costs: Over time, higher costs of sales have been creating problems for Kennametal. On a year-over-year basis, the metric increased 4.3% and 1.8% in the fiscal first quarter and second quarter, respectively. The increase in costs was mainly due to rise in manufacturing costs (in some locations) and higher raw material costs.

For fiscal 2019, inflation in raw material costs remains a concern. In unchecked, higher costs and operating expenses will prove detrimental to the company's margins and profitability.

Long-Term Debt: Kennametal’s long-term debt was at $591.7 million at the end of second-quarter fiscal 2019, reflecting marginal increase over the previous quarter and fiscal 2018. Interest expenses in the reported quarter reflected 12.1% year-over-year growth.

We believe that fresh issuances of debt instruments will increase this balance and in turn, inflate the company’s financial obligations. In unchecked, high-debt levels can prove detrimental to its profitability in the quarters ahead.

Forex Woes: Geographical diversification is reflective of a flourishing business of Kennametal. However, this diversity exposed the company to headwinds arising from geopolitical issues and unfavorable movements in foreign currencies. In second-quarter fiscal 2019, forex woes adversely impacted sales by 3%.
 
Persistence of fluctuation in foreign currencies will continue to adversely impact Kennametal’s financials.

Stocks to Consider

Some better-ranked stocks in the Zacks Industrial Products sector are DXP Enterprises, Inc. (DXPE - Free Report) , Sun Hydraulics Corporation (SNHY - Free Report) and Roper Technologies, Inc. (ROP - Free Report) . All these stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

In the past 60 days, earnings estimates for all the three stocks have improved for the current year. Further, average earnings surprise for the last four quarters was positive 46.55% for DXP Enterprises, 2.27% for Sun Hydraulics and 4.96% for Roper.

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