CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Rating (IDR) and long-term ratings for Kennametal Inc. (Kennametal) at 'BBB'. The Rating Outlook is Stable. A full list of ratings follows at the end of this press release.
The ratings and Outlook reflect Fitch's expectations that Kennametal's operating results will remain solid despite a still weak operating environment. Lower costs from restructuring and stable commodity prices resulted in double digit operating EBIT and record free cash flow (FCF) in fiscal 2013, despite -9% organic revenue growth.
Order trends remain negative but appear to have bottomed and Kennametal is anticipating gradual recovery in most end markets for fiscal 2014. Kennametal's focus on expanding presence in faster growth developing markets and increasing sales through distribution should augment low single digit revenue growth for the year.
Kennametal is anticipating relative strength in transportation construction and general engineering markets over the near-term, while mining activity should remain weak and projects within energy markets choppy until at least the second half of fiscal 2014. Nonetheless, long-term growth drivers remain solid but cyclical in each of Kennametal's end markets.
Fitch expects operating EBIT will range from 10% to 15% through a normalized cycle, driven by lower operating expense from past restructuring. Nonetheless, Fitch anticipates the full reinstitution of incentive compensation and incremental investments for expansion in developing economies will limit Kennametal's ability to drive operating expenses meaningfully below 20% of revenues.
Fitch anticipates $100 million to $200 million of annual FCF, after the company posted record FCF for fiscal 2013. Lower capital spending has contributed to increasing FCF margins; however, previously deferred higher capital spending in fiscal 2014 could offset growing profits.
With modest debt maturities and pension contributions over the next few years, the company will use cash for acquisitions, or for a mix of share repurchases and dividends. During fiscal 2013, Kennametal increased the share repurchase program, under which there were 10.4 million shares available for repurchase at June 30, 2013. The company has also increased dividends more than 10% in each of the last three years.
Fitch expects solid mid-cycle credit protection measures for the ratings over the longer term, given cyclicality of the business. Total debt to operating EBITDA, which Fitch estimated was 1.8x for fiscal 2013, should remain below 2x, with free cash flow (FCF) to debt (20% for fiscal 2013) ranging from 10% - 20%. Nonetheless, Fitch expects acquisitions will be at least partially debt funded, likely weakening credit protection measures over the short-term FCF used to bring credit metrics back in line with long-term levels over the subsequent 12 to 18 months.
Kennametal's pension plans were underfunded by approximately $95 million but a substantial portion is related to unfunded plans outside the U.S. Kennametal plans to contribute $12.2 million and $2.1 million to the pension and other post-retirement benefit plans, respectively, in fiscal 2014.
KEY RATING DRIVERS
The ratings incorporate Kennametal's:
--Leading market positions due to solid product diversification and
--Positive FCF through the business cycle from solid profitability and counter-cyclical working capital model; and
--Conservative financial policies.
Concern's center on Kennametal's:
--Exposure to business cycles, since the company derives much of its revenue from consumable, short cycle products that can be sensitive to economic conditions;
--Volatile commodity prices, resulting in uneven gross profit margins; and
--Integration risks related to acquisitions.
Kennametal's liquidity at June 30, 2013 was sufficient and consisted of:
--Approximately $377 million of cash, the majority of which is located
outside the U.S.;
--$595 million available under the company's $600 million bank revolving credit facility expiring in 2018.
More than $100 million of annual FCF also supports liquidity. The company also had uncommitted credit lines with various commercial banks of approximately $90 million, translated into U.S. Dollars at June 30, 2013.
Total debt as of June 30, 2013 was approximately $748 million and primarily consisted of:
--$400 million of senior notes due 2019; and
--$300 million of senior notes due in 2022.
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; and
--Structurally higher operating profit margin.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Sustained operating margin pressure from a lower sales mix or
inability to pass through commodity price inflation; or
--Weak FCF from an inability or unwillingness to reduce inventory, moderate capital spending, or ongoing robust annual dividend growth.
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'.
Fitch's actions affect approximately $1.3 billion of total debt, including the $600 million revolving credit facility expiring 2016.
Additional information is available at 'www.fitchratings.com'.