Kennametal (KMT)

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End markets often reflect the state of the economy they operate in, so KMT has made several acquisitions and divestments to shift some of its dependence away from the U.S. economy and towards more international markets, in order to reduce its risk. Rising costs for materials like steel and tungsten affect the entire machine tools industry, and force Kennametal to raise prices or cut costs to avoid shrinking margins. Though the company chose to raise price slightly, at an average of 3%, it focused its efforts on trimming costs through the Lean Initiative program; in the first year of the program, 2005, the company saved $35 million and increased net margins by 2.5%.^[1]

[edit] Business Financials

Kennametal operates two main segments:

• Metalworking Solutions and Services Group (MSSG) (66% of sales) -- The MSSG segment produces metal-cutting tools and tooling systems and sells them to industrial manufacturing companies and distributors, including Updike Supply.^[2]
• Advanced Materials Solutions Group (AMSG) (34% of sales) -- The AMSG segment manages the production and sale of cemented tungsten carbide products used in mining, highway construction and engineering applications requiring wear and corrosion resistance. AMSG's most renowned product, tungsten carbide tooling, is sold to engineering firms, construction firms, and industrial suppliers, including Greenfield Industries.^[3]

From March 2003 to November 2007, Kennametal's stock prices increased from a split-adjusted low of $13.50/share to a split-adjusted high of $45.60/share. From 2006 to 2007, the company's net profit margin increased from 6.64% to 7.50% (Q1 2008: 3.47%). Kennametal focuses on staying on the cutting-edge of manufacturing tools, so products made within the last five years contribute 40% to KMT sales.

[edit] Trends and Forces

[edit] End markets determine Kennametal production

Since Kennametal is primarily an industrial supplier, the health of the economy's end markets are crucial to Kennametal's success. Increased global industrial production will directly affect Kennametal's product manufacturing by causing demand for its industrial tools to rise. The general engineering end market is KMT's main buyer (43% of sales). This end market involves KMT selling its tungsten carbide tooling and advanced materials to various manufacturing businesses, from waste water treatment to animal food processing.^[4] The automotive industry affects Kennametal's second-largest end market, on-highway vehicles (28% of sales). KMT sells axles and bearings to the automotive industry. Every market trend affects the outcome of Kennametals' business strategies. High oil prices, for example, have caused increased exploration for new energy taps, which in turn increase demand for KMT's earth-drilling tools. From Q1 (9/30/07) to Q3 (3/31/08) of Kennametal's fiscal year, AMSG (34% of sales) sales grew 9.8%.^[5]

[edit] Kennametal has Dumped Big Subsidiaries for Niche Acquisitions to Expand Internationally

Since Kennametal products are sold to several end markets, the state of an economy drives Kennametal's success; the strength of an economy is an indicator of the strength of its end markets. KMT believes the U.S. is entering a recession, and hopes that international expansion will reduce revenue loss by causing the company to be less dependent on the U.S. economy. To this end:

Some of Kennametal's past acquisitions include

• Camco (2006) -- In 2006, KMT acquired Camco and Sintec for $97.5 million, including an additional payment of €12.0 million (to be paid in 2011).^[6] Camco supplies and manufactures Carbide and atomic packing factor Superalloy cutting tips for the sawmill industry worldwide.
• Sintec (2006) -- Sintec manufactures ceramic engineered components used in the aerospace, general engineering, metal making and medical industries.
• International Specialty Alloys, Inc. (2007)-- During 2007, KMT acquired KENCI, S.A., International Specialty Alloys, Inc., and Federal Signal’s cutting tool business for $165.1 million. ISA, a part of AMSG (34% of sales), manufactures high-purity specialty metal products for the aerospace, defense, and super alloy industries
• KENCI, S.A.: MSSG's (66% of sales) Spanish arm.
• Federal Signal's cutting tools business (2007) -- Makes metal cutting tools with MSSG (66% of sales).

Some of the company's divestments include

• Full Service Supply (May 2005) -- On May 1, 2005, Kennametal divested Full Service Supplies (FSS) for a selling price of $39.3 million. FSS installed supply programs that provided inventory management systems.
• J&L Industrials (June 2006) -- On June 1, 2006, Kennametal divested J&L Industrials for a selling price of $359.2 million. J&L distributed metalcutting tools, abrasives, drills, machine tool accessories, precision measuring tools, gages, hand tools and other supplies used in metalcutting operations.

After completing these divestments and acquisitions, Kennametal's operating margins increased from 10.4% to 11.3%, net profit margin increased from 6.64% to 7.50%, total assets increased from $2.4 million to $2.6 million, and total debt decreased 11%^[7] . From 2005 to 2006, the MSSG (66% of sales) sector had sales increase 12.5% due to increased international sales (a 15.0% increase in Europe, 21.4% increase in Asia, and 14.5% increase in India).^[8] Half of Kennametal's sales come from the U.S., 24% from Europe, and 26% from the rest of the world. In the past two years, Kennametal has expanded it's geographical production, as sales in Asia increased to 10%.

[edit] Kennametal Adjusts to Changing Raw Material Costs

Steel, Cobalt, and Tungsten are the three main raw materials used in Kennametal product manufacturing. Since 2005, tungsten APT prices have increased 160%, to $255 USD per metric ton in 2007, and tungsten ore prices have increased 146% per year, to $160 USD per metric ton in 2007. Since 2004, Cobalt prices have decreased 22%, to $14.27 USD per pound in 2007.^[9] Both have seen price increases thanks to the economic growth of emerging markets and rising demand for industrial equipment.

To offset these increases in cost, Kennametal chose to increase net product prices by 3%, but achieved revenue and income growth by creating the Lean Initiatives program in 2005 to reduce costs and eliminate waste. Kennametal saved $35 million in the first year of the Lean Initiatives Program, while net profit margin increased 2.50 percentage points. ^[10]

[edit] Competition

• Kennametal (KMT)- Global producer of tools, machine accessories, and advanced materials and second largest metal cutting tools manufacturer in the world.^[11]

[edit] Machine Tools & Accessories

• Stanley Works (SWK)- SWK is manufactures consumer and industrial tools.
• Timken Company (TKR)- TKR is the world's largest manufacturer of tapered roller bearings and a U.S. producer of steel alloy.
• Kaydon (KDN)- KDN is a manufacturer of specialty bearings, and also manufactures machine parts and steel alloys.
• CompX International (CIX)- CIX manufactures security products and precision ball bearing slides.^[12]
• Hardinge (HDNG)- HDNG produces machine tools in Western Europe.
• Thermadyne Holding (THMD)- THMD produces gas and electric arc cutting and welding products for the Americas.
• RBC Bearings (ROLL)- ROLL manufactures bearings; 90% of its sales are from the U.S. and it has the second-highest return on equity in the past year.^[13]
• Flow International (FLOW)- Flow produces high-pressure waterjet cutting tools and had the highest revenue growth of machine tools companies in the past quarter.

[edit] Metal Cutting Tools

• Sandvik (STO:SAND)- This Sweden- based company is the highest global manufacturer of metal cutting tools.^[14]
• Iscar Metalworking- Iscar is a Berkshire Hathaway-owned machine tools company located in Israel.

[edit] References

1. ↑ Seeking Alpha, "Kennametal Inc. F3Q08 Earnings Call Transcript," 04/28/08
2. ↑ Tooling and Production, "Distributing Success," Jan 2007
3. ↑ Tooling and Production, "Distributing Success," Jan 2007
4. ↑ North County Times, "Study: Fallon tungsten source not natural," 08/09/2007
5. ↑ KMT 2007 10-Q, Q1, Item 1: Financial Statements, page 15
6. ↑ KMT 2007 10-k, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operation, page 12
7. ↑ Kennametal 2007 Annual Report
8. ↑ KMT 2007 10-k, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operation, page 12
9. ↑ KMT 2007 10-k, Item 1: Business, page 2
10. ↑ KMT 2007 10-k, Item 1: Business, page 1
11. ↑ KMT 2007 10-k, Item 6- Selected Financial Data, page 11
12. ↑ Yahoo! Finance: CIX
13. ↑ Yahoo! Finance: Machine Tools and Accessories Leaders and Laggards
14. ↑ Sandvik Financial Key Ratios 04/06/08
15. ↑ KMT 2007 10-k, Item 6- Selected Financial Data, page 11
16. ↑ THMD 2007 10-k, Item 6: Selected Financial Data, page 18
17. ↑ CIX 2007 10-k, Item 6: Selected Financial Data, page 15
18. ↑ HDNG 2007 10-k, Item 6: Selected Financial Data, page 21
19. ↑ ROLL 2007 10-k, Item 6: Selected Financial Data, page 18
20. ↑ Sandvik Financial Key Ratios 04/06/08
21. ↑ TKR 2007 10-k, Item 6: Selected Financial Data, page 18
22. ↑ SWK 2007 10-k, Item 6: Selected Financial Data, page 14
23. ↑ KDN 2007 10-k, Item 6: Selected Financial Data, page 9