Investing in recovery prospects can be incredibly risky. But at the same time, it can also be very rewarding. A great example of a spin that has so far proven to be a good move is kenna metal (New York Stock Exchange:KMT). As a company focused on metal cutting tools and other products, as well as the production of various infrastructure products, you may not think this is an attractive place to play. But with a solid performance in both its outperformance and outperformance, stocks have done well recently. Of course, a big question is whether or not this performance will continue. In the coming days, management is expected to report financial results covering the first quarter of the company’s fiscal year 2023. Although revenue growth is expected to continue, profitability is expected to worsen somewhat. Even if this comes to pass, stocks could still offer a bigger upside going forward. But obviously investors need to be cautious given the broader economic environment.
Good results and mixed expectations
The last time I wrote an article about Kennametal was in early July of this year. In that article, I talked about how the company suffered significantly due to the COVID-19 pandemic. However, I also talked about the strong recovery that management achieved and was impressed by how cheap the stock was. I even went so far as to describe the company as an attractive game changer. At the end of the day, these findings led me to rate the company ‘buy’, reflecting my belief that the stock should significantly outperform the broader market for the foreseeable future. Since then, things have been going pretty well. While the S&P 500 is up just 2.9%, shares of Kennametal have generated a return for investors of 17.7%.
When I last wrote about the company, we only had data that covered up to the third quarter of its fiscal year 2022. Today, we now have data that covers the quarter final also. During that quarter, sales totaled $530 million. That represents a 2.7% improvement over the $35.1 million generated in the same period a year earlier. Had it not been for foreign currency fluctuations, the advantage would have been even greater. I say this because the company’s organic growth was strong at 7%. When it comes to specific segments, the biggest weakness came in the company’s metalcutting operations, with revenue up just 1%. Meanwhile, infrastructure-related sales strengthened 5% from around $204 million to $214 million, with organic revenue growth of 7%.
This increase in income brought with it an improvement in profits. Net income, to begin with, increased from $35.1 million in the fourth quarter of 2021 to $41.7 million in the same period this year. Other profitability metrics followed suit, with EBITDA rising from $100.4 million to $102.1 million. Unfortunately, operating cash flow took a beating, falling from $96.5 million in the last quarter of 2021 to $88.4 million in the same period this year. But if we were to adjust for changes in working capital, we would have seen the metric rise from $72.5 million to $89.2 million.
As a result of this performance on both the top and bottom lines, the company finished 2022 quite strongly. Revenue of $2.01 billion exceeded the $1.84 billion generated just a year earlier. But of course, sales haven’t fully recovered considering that revenue in 2019 was $2.38 billion. The company’s bottom line also improved. Net income, for example, increased from $54.4 million in 2021 to $144.6 million last year. Operating cash flow decreased from $235.7 million to $181.4 million. But if we were to adjust for changes in working capital, it would have increased from $210 million to $310.2 million. And over that same time period, we also saw an improvement when it came to EBITDA. That metric eventually increased from $282.7 million to $369.9 million.
When it comes to fiscal year 2022 in its entirety, the administration has been a bit vague when it comes to guidance. They said the pricing actions are expected to offset raw material costs, wage inflation and other inflationary pressures. And they also said that free operating cash flow should be around 100% of adjusted net income. The company, however, has provided data for the first quarter. They currently anticipate revenue of between $480 million and $500 million. And that should happen despite a $25 million to $30 million headwind associated with foreign currency fluctuations. By comparison, in the first quarter of last year, the company generated revenue of $483.5 million. And today, analysts currently forecast sales of $488.1 million. Management hasn’t been as helpful when it comes to profitability, only providing guidance for adjusted operating profit. But for the quarter, analysts expect the company to generate earnings per share of $0.36. That would be lower than the $0.43 per share generated in the same quarter last year. In absolute dollars, this would imply a decrease of $36.2 million to $30.2 million. Most likely, this decrease will also translate into a drop in cash flow. But no real guidance has been given on that front.
But really beyond that, shareholders are left in the dark. Instead of forecasting what the future might hold, I decided to rely on the data provided starting in 2022. Using 2022 data, I calculated that the company is trading at a price-to-earnings multiple of 14.4, priced to trades adjusted. cash flow multiple of 6.7, and an EV to EBITDA multiple of 7.2. These members compare favorably to the 2021 data, with metrics of 38.2, 9.9, and 9.4, respectively. As part of my analysis, I also compared the company to five similar businesses. On a price to operating cash flow basis, four of the five companies were positive, with multiples between 14.4 and 33.9. And using the EV to EBITDA approach, the range was between 10.4 and 16.1. In both cases, Kennametal was the cheapest of the bunch.
|Company||Price / Operating Cash Flow||EV / EBITDA|
|Mueller Water Products (MWA)||33.9||10.8|
|Hillman Solutions (HLMN)||N/A||16.1|
|Helios Technologies (HLIO)||17.0||10.4|
|ESCO Technologies (ESO)||24.6||16.0|
Truth be told, I think easy money has been made when it comes to Kennametal. Having said that, I also think the stock is cheap enough to warrant some upside potential. As well as being cheap in absolute terms, shares are also attractively priced compared to many other companies. Add in the expectation of further sales growth and put in some padding to account for a possible decline in earnings year over year, and I think the company makes a soft ‘buy’ from this point.