Here’s Why Kennametal Stock Is Vulnerable To Downside Risk

by Trefis Team
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We believe that the stock price of Kennametal (NYSE:KMT), a tooling and industrial materials supplier, looks fully valued at current levels of around $38. KMT stock has risen 2.5x from levels of under $15 on March 23, 2020, when broader markets made a bottom. This compares to the S&P which has risen 89% over the same period. This outperformance can be attributed to the company’s better than estimated earnings growth over the recent quarters, and an expectation of an improved demand environment, especially for energy and aerospace, boding well for Kennametal’s Metal Cutting segment.

While the future looks promising for Kennametal, it has faced headwinds during the Covid-19 pandemic, impacting its overall revenue and earnings growth, as we discuss in the section below. Now that the stock has seen a large rise (up 25% in the last one year) despite revenue falling 19% y-o-y over the last four quarters, we believe KMT stock is vulnerable to downside risk in the near term. Our dashboard ‘Buy Or Fear Kennametal Stock‘ provides the key numbers behind our thinking.

Looking at a longer time period, KMT stock is down 21% from levels of $48 seen toward the end of 2017. The decline in the stock price over the last three years or so can be attributed to unfavorable changes in the company’s P/S multiple as well as its revenue per share (RPS). Kennametal’s revenues declined 8% to $1.9 billion in fiscal 2020 (fiscal ends in June), compared to $2.1 billion in 2017. Furthermore, total revenue declined to $1.7 billion for the last twelve month period, primarily due to the impact of the Covid-19 pandemic on the company’s business. There has been no meaningful change in total shares outstanding, and on a per share basis, the company’s revenue saw a decline of 9% to $23.31, compared to $25.55 in 2017. RPS has further plunged to $20.50 for the last twelve month period.

Given a decline in its RPS, the company’s P/S multiple contracted from levels of 1.9x in 2017 to 1.6x in 2020. While the P/S multiple remains around 1.6x currently, we believe that it will likely decline going forward.

Outlook

Kennametal’s business is not immune to the pandemic, and it saw its overall revenue falling over 12% to $1.3 billion for the nine month period ending March 2021. Both of the company’s segments – Metal Cutting and Infrastructure – have seen low double-digit declines over this period. Looking at the company’s performance in fiscal Q3 2021, total revenue of $485 million was marginally above the $483 million seen in the prior year quarter. However, they were up 10% sequentially, implying that the demand has improved for Kennametal’s business. The company’s Q3 revenues were actually better than the street estimate of $470 million, while its earnings per share of $0.32 was much higher than the consensus estimate of $0.20.

Looking forward, Kennametal will likely see increased profitability, given the improved demand environment, as well as the company’s efforts to improve its margins. The company’s operating margins improved 330 basis points sequentially in Q3, driven by cost-cutting measures, a trend expected to continue in the near term.

That said, much of these positives appear to be priced in the current stock value of $38 for Kennametal. In fact, at the current price of $38, KMT stock is trading at 1.7x its full year 2021 expected RPS of $21.85, based on consensus estimate. This compares with RPS of $28.87 and $28.98 seen in 2019 and 2018, respectively. The 1.7x P/S multiple compares with levels of 1.3x seen in 2019, and 1.1x seen in 2018, implying that KMT stock is vulnerable to downside risk.

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