Kadant (KAI) trades at an attractive multiple given its strong balance sheet and cash flow, diversified operations with emerging markets exposure and shareholder friendly management.
KAI supplies equipment used in the global papermaking and paper recycling industries. Its customers includes many of the largest global paper manufacturers and it has one of the largest installed equipment bases in the industry. The two operating segments include:
Papermaking systems. KAI manufactures stock-preparation (recovers recycled fibers and processes virgin fibers), fluid-handling (transfers fluids, steam or air between rotating cylinders and fixed piping) as well as doctoring, cleaning and filtration products (cleans roll surfaces and fabrics as well as filters and recycles process water).
Fiber-based products. KAI manufactures granules derived from pulp fiber for use in agricultural, lawn and garden as well as oil and grease absorption applications.
KAI is undervalued on an absolute and relative basis, especially given the favorable company specific factors mentioned below.
KAI should trade at a premium to Metso as the latter has exposure to the mining industry (currently suffering from reduced capex) and significantly higher debt (net debt/equity of 27%).
The current multiple does not reflect the strong and improving financial performance in multiple areas including:
High and rising cash flow. In the mrq, operating cash flow rose 30% to $11.1 million.
Significantly improved debt profile. In the mrq, net cash rose 61% to $48.5 million while the leverage ratio continues to fall. Furthermore, KAI used only ~$10 million of its $100 million credit line.
Source: Company presentation
Rising margins. In the mrq, gross margins rose 490 basis points to a record 48.6% (exceeding the previous record by 100 basis points) due to a more favorable product mix of higher margin parts and consumables (64% of total revenues vs. 57% in the year ago period) provided by its large installed base. The market has been slow to adjust for the shift away from the lower margin capital equipment business.
Furthermore, the low-cost manufacturing operations in China and Mexico as well as multiple workforce reductions over the past five years (2008, 2009 and 2011) provide significant operating leverage.
Classic "beat and raise" quarter. In the mrq, management raised revenue guidance to $340-345 million from $336-343 million and adjusted diluted EPS guidance (excluding restructuring costs and gain on sale of asset) to $2.03-2.08 from $1.90-2.00. Adjusted diluted EPS of $0.51 exceeded guidance of $0.43-0.45.
Shareholder friendly management is a significant catalyst
KAI continues to return excess capital to shareholders through repurchases and buybacks.
In May 2013, KAI declared its first quarterly dividend of $0.125.
The board did not renew a shareholder rights plan that expired in July 2011, which leaves the company vulnerable to a strategic/financial buyer.
Diversified operations reduce risk while emerging markets exposure provides growth
KAI is diversified by customer (no single customer accounts for more than 10% of total revenues) and product...
KAI continues to grow through targeted acquisitions. In April 2013, KAI acquired long-time licensee Companhia Brasileira de Tecnologia Industrial and expanded further into South America with higher growth and low per capita paper usage. In May 2013, KAI acquired assets of the Noss Group, a Sweden-based developer and supplier of high-efficiency cleaners and approach flow systems. This acquisition will increase the shift to higher margin parts and consumables.
KAI will benefit from strong Chinese growth. In the mrq, Chinese total bookings increased 54% while higher margin parts and consumables bookings doubled. Management said on the most recent conference call that China continues to close smaller inefficient mills, which is actually a positive because those smaller mills in general were not KAI customers and that the supply will be absorbed by larger mills.
Foreign exchange risk. KAI is exposed to foreign exchange risk through its significant foreign operations. This risk is managed through the use of forward contracts and charging customers in the same currency as operating costs.
Commodity exposure. KAI uses steel, brass, bronze, natural gas and other commodities to manufacture its products and would be negatively affected by price increases.
Competition. In the stock-preparation systems and equipment segment, competitors include Voith Paper GmbH, Metso and Andritz. In the fluid-handling systems and equipment segment, competitors include Deublin, Christian Maier GmbH and Duff-Norton. In the doctoring systems and equipment segment, competitors include Joh. Clouth GmbH, Metso and Bonetti. In the formation, shower and fabric-conditioning and filtration systems segment, competitors include Metso, Voith Paper GmbH, IBS-Paper Performance Group, AstenJohnson's Paperchine subsidiary and Spraying Systems.
Weakness in Europe and China. KAI is negatively affected by the continuing weak economic growth in Europe and the recently slower growth in China. This risk is mitigated by the recent signing of two contracts in Europe, the bifurcated market (strength in Germany, the UK and Eastern Europe offsets weakness in Western Europe) and low containerboard inventories, which resulted in price increases.
Pension plan liability. KAI has ~$11 million in unfunded pension obligations.
The target price of $38.31 is based on an 8.5x EBITDA multiple.
A tight stop loss should be placed below the 50 DMA ~3% below. The time frame is 6-12 months given the conservative price target, high growth and strong technical position.