Close

Moody's Lowers Outlook on Kennametal (KMT) to Negative

January 20, 2015 3:52 PM EST

Moody's Investors Service affirmed the Baa2 senior unsecured rating of Kennametal Inc. (NYSE: KMT), a leading global supplier of tooling, engineered components and advanced materials consumed in production processes. The ratings outlook was revised to negative from stable.

The following ratings were affected by this action:

$400 million 2.65% senior unsecured notes due 2019, affirmed at Baa2;

$300 million 3.875% senior unsecured notes due 2022, affirmed at Baa2;

Multiple Seniority Shelf due 2015, affirmed at (P)Baa2;

Rating outlook is negative.

RATINGS RATIONALE

The change in outlook reflects Kennametal's elevated leverage metrics since the acquisition of TMB in November 2013. While Kennametal has made progress in reducing debt, we expect adjusted debt-to-EBITDA to remain high for the Baa2 rating over the near-term. Adjusted debt-to-EBITDA was 3.1x for the trailing twelve months ending September 30, 2014. A number of the company's end markets are weak and are expected to remain sluggish in 2015 which will pressure Kennametal's revenues and earnings. Earthworks sales continue to be negatively impacted by weak underground coal mining markets in the U.S. and China as well as lower highway construction activity. Aerospace and defense sales, while supported by a commercial aircraft production, are expected to be slower in 2015, and military spending is expected to remain weak. In addition, we believe Kennametal's revenues and earnings will be further pressured in 2015 by the abrupt change in the global energy market, which will result in lower drilling activity. Weakness in the European industrial business persists. The strength of the U.S. dollar and volatility in input costs could also add pressure to earnings.

Kennametal's Baa2 senior unsecured rating is supported by the company's position as a leading global supplier of tooling and engineered components, broad product, end market and geographic diversity, its conservative financial policies and focus on debt reduction. The company's ratings are also supported by its good liquidity. The rating reflects our expectation that Kennametal will continue to employ conservative financial policies and will continue to de-lever using cash flow from operations.

Kennametal's limited overall size, vulnerability to cyclical end markets, exposure to volatile input costs, including tungsten, cobalt, and steel, constrain the rating. Despite its diversity and the consumable nature of the majority of its products, the company is exposed to significant volatility of its end markets. Adjusted EBIT margins have declined to 9.6% as of the trailing twelve months ended September 30, 2014 from 11.6% at fiscal year ended June 30, 2013. Adjusted free cash flow-to-debt has weakened to 6.9% at trailing twelve months ended September 30, 2104 from 14.0% at fiscal year ended June 30, 2013. This metric is expected to improve over the intermediate term, but still remains weak for the rating.

Kennametal maintains a good liquidity profile, supported by its $600 million revolving credit facility due April 2018, of which approximately $386.5 million was available at September 30, 2014, its cash balance of approximately $156 million, ample cushion under financial covenants, and lack of debt maturities until November 2019 when $400 million of 2.65% senior unsecured notes are due. Financial covenants in the credit agreement include a maximum debt-to-EBITDA leverage ratio and a minimum EBITDA-to-interest coverage ratio. At September 30, 2014 the company had considerable room under these financial covenants and, in our view, is likely to continue maintaining this cushion over the next 12 to 18 months. Additionally, Kennametal is expected to generate sufficient cash flow to cover its working capital requirements, capital expenditures, and dividends.

The negative outlook reflects our expectation that Kennametal's earnings will be pressured in 2015 from weakness in many of its end markets and, as a result, adjusted debt-to-EBITDA will remain high for the rating, adjusted EBIT margins will remain weak and cash flow generation will be lower than originally projected following the TMB acquisition.

A return to stable outlook would be predicated upon adjusted debt-to-EBITDA below 2.5x and adjusted EBIT margins in excess of 10%. Upon stabilization, an upgrade would be considered in the event that the company proves able to further build its scale, generates adjusted EBIT margins above 15%, and maintain its fully adjusted debt-to-EBITDA comfortably below 2.0x on a consistent basis, while generating strong free cash flow and maintaining solid liquidity.

The ratings could be downgraded if the company's revenues and credit metrics weaken from current levels. Over the intermediate-term if adjusted EBIT margins remain below 10% and adjusted debt-to-EBITDA remains above 2.5x for an extended period of time, the ratings could be downgraded. Large debt financed acquisitions or share repurchases that would result in debt-to-capital exceeding 35%for an extended period of time could also drive the rating down.

The principal methodology used in these ratings was Global Manufacturing Companies published in July 2014. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.



Serious News for Serious Traders! Try StreetInsider.com Premium Free!

You May Also Be Interested In





Related Categories

Credit Ratings

Related Entities

Dividend, Moody's Investors Service, Earnings, Definitive Agreement