Kennametal’s Sales Hit by Weakness in Energy Market

Phase 1 of its restructuring activities delivers pre-tax savings of $40-$45 million

k1Global industrial tooling and materials supplier, Kennametal Inc. (NYSE: KMT) announced its Q4 FY16 and full year FY16 financial results on August 1st, 2016. The Latrobe, Pennsylvania-based company is a supplier of tooling, engineered components and advanced materials consumed in production processes. The Company manages and reports its business in two segments: Industrial and Infrastructure. The Company provides wear-resistant products, application engineering and services for the industrial production, transportation, earthworks, energy, infrastructure and aerospace sectors. End users of the Company’s products include manufacturers, metalworking suppliers, machinery operators and processors, engaged in an array of industries, including the manufacture of transportation vehicles and systems; machine tool, light machinery and heavy machinery industries; airframe and aerospace components and systems, defense, as well as producers and suppliers in equipment-intensive operations. Read more about Kennametal’s financial results below.

Q4 FY16 financial highlights

Kennametal’s Q4 FY16 sales slid 18% to $521 million compared to $638 million in the year-ago period, reflecting a 9% decline due to divestiture, a 9% organic sales decline and a 1% unfavorable currency exchange impact, offset partially by a 1% gain due to more business days.

Operating income came in lower at $25 million compared to $35 million in the same quarter last year. Adjusted operating income was also lower at $47 million compared to $53 million in the prior year quarter, mainly due to a decline in organic sales and unfavorable mix in both segments, partially offset by lower raw material costs and restructuring benefits. Adjusted operating margin slipped to 9% in the reporting quarter versus 9.2% in the prior year period.

During Q4 FY16, Kennametal recorded a discrete tax charge of $81 million, or $1.02 per share, associated with a valuation allowance with regards to deferred tax assets in the U.S. On a combined basis, pre-tax restructuring and related charges amounted to $16 million, or $0.10 per share, and pre-tax benefits were approximately $20 million, or $0.19 per share in the quarter.

Due to higher taxes and lower sales, Kennametal swung to a loss, reporting a loss per share of $0.83 during Q4 FY16 compared to the prior year’s Q4 EPS of $0.26.

During Q4 FY16, Kennametal generated year-to-date lower free operating cash flow of $115 million compared to $267 million in the prior year. The decrease in free operating cash flow was primarily by lower cash earnings, higher net capital expenditures and higher restructuring, tax and pension payments, partially offset by reductions in working capital.

Segmental highlights

Industrial segment: During Q4 FY16, Kennametal’s Industrial segment sales fell 8% to $329 million in Q4 FY16 from $358 million in the prior year quarter due to organic sales decline of 8% and unfavorable currency exchange of 1%, partially offset by a 1% increase due to more business days. Excluding the impact of currency exchange, sales decreased approximately 17% in energy, 8% in general engineering and 4% in transportation, while increasing 9% in aerospace and defense. Energy market sales declined at a slower pace. Stable transportation market sales in the Americas and EMEA were more than offset by fewer machine deliveries in Asia. Aerospace sales grew across all regions with stronger growth occurring in EMEA and Asia. On a segment regional basis, excluding the impact of currency exchange and divestiture, sales decreased 11% in Asia, 8% in the Americas, and 1% in Europe.

Source: Kennametal
Source: Kennametal

During Q4 FY16, the Industrial segment’s operating income was lower at $29 million compared to $40 million in the prior year period. Adjusted operating income was $41 million compared to $50 million in the prior year quarter, due to organic sales decline and unfavorable product mix, partially offset by lower raw material costs and incremental restructuring benefits. Industrial adjusted operating margin was lower at 12.4% compared with 14.2% in the prior year.

Infrastructure segment: During Q4 FY16, Kennametal’s Infrastructure segment sales fell 31% to $193 million from $280 million in the prior year period, due to the divestiture impact of 20%, organic sales decline of 11%, and a 1% unfavorable currency exchange, partially offset by a 1% increase due to more business days. Excluding the impact of currency exchange, Infrastructure sales fell 23% in energy, 13% in earthworks and 10% in general engineering. The energy market was impacted by continuing weakness in oil and gas end markets. Additionally, challenging conditions in underground mining continued to hurt sales in North America, while highway construction sales showed improvement in conjunction with the road rehabilitation season. On a segment regional basis, excluding the impact of divestiture and currency exchange, sales rose 5% in Europe, while sales decreased 18% in the Americas and 11% in Asia.

Source: Kennametal
Source: Kennametal

During Q4 FY16, the Infrastructure segment’s operating loss was $4 million in both 2016 and 2015, respectively. Adjusted operating income grew to $6 million compared to $2 million in the prior year’s quarter, as the effects of divestiture and unfavorable mix were more than offset by incremental restructuring benefits. Infrastructure adjusted operating margin rose to 3.4% compared with 1.1% in the prior year period.

Full year FY16 financial highlights

For FY16, Kennametal’s sales fell 21% to $2,098 million, compared with $2,647 million in FY15, due to an 11% organic sales decline, a 5% divestiture impact, and a 5% unfavorable currency exchange impact. Combined restructuring programs delivered full fiscal 2016 year-over-year incremental savings of approximately $44 million.

Source: Kennametal
Source: Kennametal

For FY16, Kennametal’s operating loss contracted to $175 million compared to loss of $358 million in the same period last year. Adjusted operating income decreased to $126 million in FY16 from $235 million in the prior year, due to organic sales decline, unfavorable product mix, lower fixed cost absorption and unfavorable currency exchange, offset partially by lower material costs, incremental restructuring benefits and manufacturing productivity improvements. Adjusted operating margin for FY16 was lower at 6.2%, compared to 9.8% in the prior year.

For FY16, Kennametal’s loss per share contracted to $2.83 compared with loss per share of $4.71 in the prior year. Adjusted EPS was $1.11 in FY16 versus EPS of $2.00 in the prior year.

In FY16, Kennametal generated net cash of $219.3 million from operating activities, down from $351.4 million in FY15. Capital spending was $110.7 million in FY16 compared to $100.9 million in FY15. Free operating cash flow declined 57% Y-o-Y to $114.6 million in FY16.

Restructuring on track

Source: Kennametal
Source: Kennametal

Kennametal’s Phase 1 of its restructuring activities has been almost completed in Q4 FY16, delivering estimated annualized pre-tax savings of $40-$45 million. The second phase of Kennametal’s restructuring activities is expected to be completed by the end of calendar year 2018. Charges are estimated at $90 million to $100 million, while annualized savings are predicted at $40-$50 million. The third phase of restructuring activities is expected to be completed by March 2017. Estimated charges are $40 million to $45 million, while annualized savings are predicted in a range of $25 million to $30 million.

Kennametal announced that it will reduce its workforce by 1,000, resulting in savings of $100 million to $110 million in FY17. In addition, the company initiated certain productivity and efficiency enhancement strategies for the next 2 to 3 years, estimated to yield savings of $200 million to $300 million.

New operating structure

In order to tap growth opportunities of its WIDIA brand, Kennametal implemented a new operating structure at the start of FY17, leading to the establishment of the WIDIA operating segment. Kennametal will now have three reportable operating segments: Industrial, WIDIA, and Infrastructure.

Dividends to shareholders

Kennametal announced that its board of directors has approved a quarterly cash dividend of $0.20 per share, payable on August 26th, 2016, to shareholders of record as on August 12th, 2016.

Guidance for full year FY17

For FY17, Kennametal anticipates total revenue to be flat compared with roughly $2 billion generated in FY16. Organic growth is expected to range between +2% and -2% during FY17. Adjusted earnings are expected within $1.10 per share to $1.40 per share. Cash flow from operating activities is projected in a range of $190 million to $230 million, while capital spending is anticipated at $100 million to $120 million. Free cash flow will likely come in at $90 million to $110 million in FY17.

Stock Performance

k6Kennametal’s stock ended the day at $28.58, slipping 0.76%, at the close on Wednesday, August 17th, 2016, having vacillated between an intraday high of $28.74 and a low of $28.42 during the session. The stock’s trading volume was at 785,166 for the day. The Company’s market cap was at $2.30 billion as of Wednesday’s close.

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