TEXT-Fitch affirms Kennametal at 'BBB'; Outlook Stable
Aug 29 - Fitch Ratings has affirmed the Issuer Default Rating (IDR) and long-term ratings for Kennametal Inc. at 'BBB'. The Rating Outlook is Stable. A full rating list follows at the end of this press release.
Kennametal's ratings incorporate the company's leading market positions, geographic diversification, conservative financial policies and low leverage. The company's solid operating results reflect demand in the company's industrial and infrastructure segments and an improved cost structure associated with previous restructuring. Debt/EBITDA at June 30, 2012 was 1.09x which Fitch views as strong for the ratings. The company used a material increase in debt during fiscal 2012 to help fund the acquisition of Deloro Stellite (Stellite) in March for $383 million. The acquisition increased Kennametal's product and geographic diversification, and should quickly support profitability and free cash flow.
Kennametal generated $143 million of free cash flow after dividends in fiscal 2012 compared to $107 million in 2011. Fitch estimates free cash flow could increase in fiscal 2013 to at least $175 million - $200 million including the impact of Stellite. Given Kennametal's low leverage, the company has the capacity to make modest debt-funded acquisitions or deploy cash for share repurchases without affecting the ratings. Cash requirements are modest, including pension contributions. Kennametal's pension plans were underfunded by $174 million at June 30, 2012, but a substantial portion is related to unfunded plans outside the U.S. Kennametal estimates it will contribute $10 million in 2013, similar to 2012.
Kennametal's exposure to business cycles remains a key credit concern. The company derives much of its revenue from consumable, short cycle products that can be sensitive to economic conditions. Credit metrics can deteriorate materially. Currently, the company's end-markets are mixed. A slowing pace of orders reflects weakness in certain energy, power generation, and construction markets, offset by steady demand in automotive and aerospace markets. Europe is likely to remain weak. In the event of a downturn, Fitch believes the company's credit metrics would be negatively affected, but the impact could be less than previous downturns due to the company's operating improvements and the absence of a solid recovery in certain markets such as construction.
Kennametal's results could become more stable as it broadens its product line and customer base and increases the flexibility of its cost structure. Mitigating concerns about the impact of a downturn are Kennametal's demonstrated ability to generate positive free cash flow through a downturn; ability to manage commodity prices through product pricing, and effective new product development that supports the company's competitive position. Other rating concerns include volatile commodity prices and normal integration risks related to Stellite.
Kennametal's liquidity at June 30, 2012 included $116 million of cash plus approximately $388 million of availability under a $600 million bank revolver that matures in 2016. Liquidity was offset by $34 million of short-term debt and current maturities. Aside from outstanding balances under the revolver, the company's only substantial debt consists of $300 million of notes due in 2022.
WHAT COULD TRIGGER A RATING ACTION
Positive: Future developments that may individually or collectively lead to a positive rating action include:
--Diversification into longer cycle products that would reduce the company's sensitivity to business cycles;
--Additional margin improvement;
--Sustained low leverage, which would support Kennametal's financial flexibility.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Margin pressure or weak FCF resulting from weak demand, high commodity prices, or unexpected operating challenges;
--Aggressive cash deployment for share repurchases or other shareholder-friendly actions that could increase debt/EBITDA materially toward 2.0x or higher.
Fitch has affirmed Kennametal's ratings as follows:
--Issuer Default Rating (IDR) at 'BBB';
--Senior unsecured bank facilities at 'BBB';
--Senior unsecured debt at 'BBB'.
Approximately $566 million of debt was outstanding at June 30, 2012.
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