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Why Is Kennametal (KMT) Down 13.8% Since Last Earnings Report?

Zacks Equity Research

A month has gone by since the last earnings report for Kennametal (KMT). Shares have lost about 13.8% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Kennametal due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important catalysts.

Kennametal Lags Q3 Earnings Estimates, Revises View

Kennametal reported weaker-than-expected results for third-quarter fiscal 2019 (ended Mar 31, 2019), with earnings lagging estimates by 3.75%. This performance came in after it recorded three consecutive quarters of impressive results.

This machinery company's adjusted earnings in the reported quarter were 77 cents, lagging the Zacks Consensus Estimate of 80 cents. However, the bottom line improved 10% from the year-ago figure of 70 cents on the back of benefits derived from the company's initiatives — including growth, modernization and simplification.

Industrial and WIDIA Lower Revenues

In the quarter under review, Kennametal generated revenues of $597.2 million, decreasing 1.8% year over year. Organic sales growth of 3% in the quarter were more than offset by 4% adverse impacts of forex woes and 1% negative impact of business days.

Also, the top line lagged the Zacks Consensus Estimate of $622.4 million by 4%.

On a geographical basis, the company generated revenues of $302.9 million from America operations, increasing 3% year over year. Sales in Europe, Middle East and Africa (EMEA) were down 6% to $181.4 million while that for the Asia Pacific operations decreased 6.6% to $112.9 million.

The company reports revenue results under three segments — Industrial, WIDIA and Infrastructure. Its segmental performance for the fiscal third quarter is briefly discussed below:

Industrial revenues totaled $318.6 million, decreasing 4.3% year over year. Organic revenues grew 1% and foreign currency translation had a negative impact of 5%.

WIDIA revenues were $51 million, down 2.4% year over year. The results were impacted adversely by forex woes of 4% and business days' impact of 1%, partially offset by organic sales growth of 3%.

Infrastructure revenues totaled $227.6 million, increasing 2.2% year over year. This improvement was due to 6% organic revenue growth, partially offset by 1% impact of business days and 3% negative impact of forex woes.

Operating Margin Improves

Kennametal’s cost of goods sold in the reported quarter decreased 0.6% year over year to $389.1 million. It represented 65.2% of revenues versus 64.4% in the year-ago quarter. Gross profit decreased 3.8% year over year to $208.1 million, wherein margin decreased 80 basis points (bps) to 34.8%. Operating expenses totaled $120.1 million in the quarter under review, decreasing 8% year over year. As a percentage of revenues, it was 20.1% versus 21.5% in the year-ago quarter.

Adjusted operating income in the reported quarter increased 3.4% year over year to $85.3 million. Margin increased 70 bps to 14.3%. Margin was driven by growth in organic sales, lower compensation expenses and gains from restructuring efforts. These positives were partially offset by rise in raw-material costs, forex woes and lower absorption of costs. Notably, inflation in raw material costs was offset by price realizations in the reported quarter. Adjusted effective tax rate was 19.8%, down from 23.1%.

Balance Sheet and Cash Flow

Exiting the fiscal third quarter, Kennametal had cash and cash equivalents of $112.6 million, increasing 16.9% from $96.3 million at the end of the last reported quarter. Long-term debt and capital leases inched up 0.1% sequentially to $592 million.

In the three months ended March 2019, the company generated net cash of $157.5 million from operating activities, decreasing 0.3% from the year-ago comparable period. Capital invested for purchasing property, plant and equipment totaled $145.9 million, above $105.6 million in the year-ago period. Free cash inflow was $15.1 million, down from $54.5 million in the nine months ended March 2018.

Outlook

For fiscal 2019, Kennametal anticipates adjusted earnings per share of $3.00-$3.10 versus the previously stated $2.90-$3.20. The revised projection is higher than $2.65 recorded in fiscal 2018. Organic sales growth is predicted to be roughly 5%, at the lower end of the previously mentioned 5-8%. Adjusted tax rate is likely to be 22% versus the earlier 22-25%.

Capital expenditure is expected to be $200-$220 million, down from the previously stated $240-$260 million and free cash flow is estimated to be $120-$140 million (maintained).

Also, the company noted that the second phase of its simplification/modernization will likely yield annualized savings of $35-$40 million by fiscal 2020 end. Related charges are predicted to be roughly $55-$65 million.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed a downward trend in fresh estimates.

VGM Scores

Currently, Kennametal has a great Growth Score of A, though it is lagging a lot on the Momentum Score front with an F. However, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of A. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, Kennametal has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.



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