Kennametal Inc. is a supplier of tooling, engineered components and advanced materials consumed in production processes. End users of the Company’s products include metalworking manufacturers and suppliers in the aerospace, automotive, machine tool, light machinery and heavy machinery industries, as well as manufacturers and suppliers in the highway construction, coal mining, quarrying and oil and gas exploration. Its end users’ products include items ranging from airframes to coal, medical implants to oil wells and turbochargers to motorcycle parts. The Company specializes in developing and manufacturing metalworking tools and wear-resistant parts using a specialized type of powder metallurgy. Its metalworking tools are made of cemented tungsten carbides, ceramics, cermets, high-speed steel and other hard materials. The Company operated two global business units consisting of Metalworking Solutions & Services Group (MSSG) and Advanced Materials Solutions Group (AMSG).
WSR: Good day from Wall Street. This is Juan Costello, Senior Analyst with the Wall Street Reporter, and joining us today is Carlos Cardoso, CEO, President and Chairman of Kennametal Inc. The company trades on the New York Stock Exchange, their ticker symbol is KMT, and they are a supplier of tooling and engineering components as well as advanced material consumed in production processes. Thanks for joining us again Carlos.
Carlos Cardoso: Thank you Juan, good morning.
WSR: Good morning, always good to have you on. Starting off, go over some of the value drivers behind the company’s Q3 results, which were able to beat the Street.
Carlos Cardoso: Yes, I think the number one driver is actually the manufacturing activity. We’ve seen positive trends in a lot of the markets that we play in as well as geographies. Obviously, the Industrial Production Index has been up for a while, so we are now experiencing some good positive growth.
WSR: Good, so you increased your earnings per share to — you had an earnings per share of $0.12 as compared to a loss of $1.9 in the last year.
Carlos Cardoso: That’s correct — that’s on a reported basis, yes.
WSR: Right, and as a result, you also increased your guidance for this year — for the rest of the year.
Carlos Cardoso: Yes, we did. We have announced $150 million to $160 million of restructuring costs as well as $150 million to $160 million in benefits from the restructuring. That is actually coming in slightly better than what we thought, so is driving our earnings to a higher level than originally anticipated at the beginning of the year. So we’re very pleased to announce — our results that are actually better than expected, and continue to see strong trends in the topline, which continue to develop better results from an earnings perspective.
WSR: Good, and so you also cut up a lot of the losses and a lot of expenses and costs.
Carlos Cardoso: That’s correct. So going forward, we anticipate to have all the restructuring and — majority of the restructuring costs and obviously the headwind from the economy behind us. So we can look for clean quarters going forward and we are — we hope that the industry continues to show the strength that it has so far.
WSR: Certainly, and so last interview we conducted last year, you described your company as a two-business concept. Can you explain that to some of our investors that are new to the story as well as kind of walk us through some of your main products and services?
Carlos Cardoso: Of course. We have two businesses. One is called MSSG or metalworking, within the metalworking business. So anything that is manufactured uses our products. That is more of an industrial type business. So it follows closely the industrials, and that represents somewhere around 55% of our business, and we have the second business, what’s called AMSG or advanced materials business that is more in the exploration business, and obviously they are the balance of our portfolio. And they have slight different cycles and different levels of profitability. The advanced materials business stayed fairly strong from an earnings perspective during the down cycle where the metalworking profitability-wise suffered more towards the — during the recession. And so now we anticipate during the upturn that although advanced materials business is a profitable business and going to continue to be profitable and improve, I think the rate of improvement in the metalworking business is going to increase at a higher rate just because of the nature of and the cycle of the business.
WSR: So would you say still about 80% of your business is made up of consumables and can you talk about the significance of that?
Carlos Cardoso: Yes, I mean 80% of our business is consumables, products that last anywhere between an hour and a couple of days, and they have to be replaced. So traditionally, as we get into this upturn, companies have to buy those consumables to manufacture their own products. From my perspective, this is a nice opportunity for us in the early cycle to — as demonstrated by our end of the quarter results that will see the growth in the topline concurrent with industrial increase in activity.
WSR: Good, and so can you identify some of the trends right now in your sector, and how well positioned is Kennametal to capitalize on them?
Carlos Cardoso: Obviously, we feel that we are very well positioned from a number of ways. The first thing that we are well positioned is the fact that we are consumables, so customers need to buy them in order to manufacture their products. The second one is that we have introduced quite a few new products during the recession. We haven’t really slowed down with our product development during this cycle. One of our goals is to have 40% of our sales come from new products. So the fact that as companies ramp up and as companies need more capacity, the fact that we have more productive products out there gives us an advantage. The second one — the third one is really from where we are positioned in the marketplace. I mean less than 50% of our business comes from North America. So we experience very, very good growth in developing economies like China, India, and Latin America, and the US is just about — has just gained some traction, and will continue to get some traction followed by Europe. So our geographical diversity in addition to our end market diversity and new products, and the fact that we are a consumable business positions us very well, and we’re very excited about this part of the cycle for our business.
WSR: Good answer, and so what would you say are some of the specific factors that make Kennametal unique from some of the other players in the sector?
Carlos Cardoso: I mean I think that there is — we bring a lot of technology and a lot of productivity into our customers. So one of the things that we do is make sure that our customers are more productive today than they were yesterday, and again, we are a productivity play. So, as factories begin to ramp up and start to getting above 50%, 60%, and 70% of their capacity, they are going to need to get more capacity and before they have to invest in capital equipment, they can transition into some of our more productive tools, so they can better utilize the equipment that they have today.
WSR: So, in terms of your background and experience, can you walk us through that of yours and also the management team for some of our investors here that are new to the Kennametal story?
Carlos Cardoso: Sure. I have been with Kennametal since 2003, and I joined Kennametal running the metalworking division, which at the time was, and still is the largest division, and progressed myself towards becoming the CEO in January of 2006 and then Chairman thereafter. And I have spent all my career in the manufacturing sector, and in many, many different industries and global businesses. I’ve been in the pumps business, I’ve been in the aerospace business for many years, and again, with no exception for the last 20 years, I’ve managed business that are global in nature. And our management team — we have a very strong, well mixed, team. We have people in our team that have been with the company for some decades that are in the leadership team, and we have some new people that have come from other industries and are new to Kennametal. And I think that that combination makes it a very good combination where we have new people that can help us think outside of the box and we have people that have been here for a while that can keep us grounded and not too far from the box, which is I think a healthy mixture. So we have great backgrounds, people from different industries that help us put the strategy of the company together and most importantly, help us very successfully implement those strategies which is — the most critical part of a strategy is the implementation.
WSR: Sounds like a good balance. So looking out into the horizon, Carlos, what do you and the management team hope to accomplish over the course of the next 12 months?
Carlos Cardoso: I think — our number one priority right now is organic growth. I mean we want to make sure that we continue to get market share and continue to grow faster than the industry, and we started this quarter by doing so, and we — based on our guidance, we anticipate the next quarter to be on the same course. So the number one priority is organic growth. Number priority is to make sure that we keep the gains that we’ve made in our cost structure to make sure that the fixed costs that we were taking out of the business in the last 18 months will stay until we get to be a $3 billion company. So we have capacity. We don’t need to invest in capital in this business to — at a higher level than depreciation to reach our $3 billion, which is very exciting for us. And as we get further along and the business continues in this trajectory, we’ve got to start thinking about some potential acquisitions and so forth, so start to looking at the priorities of cash.
WSR: Right. So in terms of some of those M&A activities, what would be some of the synergies that you would look for?
Carlos Cardoso: Typically, we look for business that are adjacent to our space and in our space. I mean, we want to make sure that we stay close to our core. It’s got to be strategic for us, and for example, in the advanced materials business, which we have said that one of our goals is to get that business to be the same size as metalworking, that business is — the market is the same size as the metalworking market and is very fragmented with high technology players. We want to buy those players and buy the technology so that we can continue to invest on the core that we have and add new technology concurrently. And obviously, the other thing that we look at is the price and the valuation. I mean (?) considered to be strategic and be a fit-in. Then we need to see — make sure that that business is accretive to our earnings goals.
WSR: Certainly, and do you believe that investors and the investment community are beginning to understand and further appreciate the Kennametal story?
Carlos Cardoso: I think based on the — in the last couple of months, how our stock is going, I think that people are beginning to understand the story. At least I feel that — I feel positive about that, but we are not an easy company to understand and we need to continue to talk to investors and continue to make sure they understand the story. I mean that’s sort of an endless journey because we’re a relatively small company, and again not easy to understand, very global; so we need to continue to communicate with all our investors and potential investors about the story of the company, which is a very exciting story.
WSR: What’s the one thing that you wish investors better understood about the company, which if they did would result in a higher stock valuation?
Carlos Cardoso: I think the fact that we believe that this company is a 15% EBIT margin capable company. I think that traditionally, the company has gone much higher than the 12%, 13% EBIT margin. So we have a legacy of a peak margin of 12% to 13%. I think that if you follow the company for the last three years, we have fundamentally changed the company, and the last — really the last step was this major restructuring program that we did that this company now is capable of hitting the 15% EBIT margin. Now, as I speak and say that, I’ve recognized the hesitation from an investor’s point of view because we have the legacy that we have. So — I think there are some investors that have bought into the story and are well capitalized on that and there’re some investors who are on the sideline, wait and see. Again, the sooner they move in, the more opportunities they will have. If they continue to stay on the sideline, I think that they will miss an opportunity from our point of view.
WSR: Well put, and so once again, joining us today is Carlos Cardoso, CEO, President, and Chairman of Kennametal Inc. The company trades on the New York Stock Exchange, the ticker symbol is KMT, and is currently trading at $32.38 a share, with a market cap of $2.64 billion. So before we conclude, Carlos, why should investors consider Kennametal (KMT) today?
Carlos Cardoso: I mean I think — the looking forward potential, I think that we are going to be able to outpace the industrial production, as we have proven capable of doing in previous recoveries, and the fact that we can become a 15% EBIT margin company, which is not too bad for an industrial company. So I think that is what is the fundamental of the story.
WSR: We certainly look forward to continuing to track the company’s growth as well as report on your upcoming progress.
Carlos Cardoso: Thank you, Juan, thank you for taking the time with us.
WSR: It’s always good to have you on, and yes, thanks for taking the time to update our investors today.
Carlos Cardoso: Thank you, have a good day.