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The old-fashioned business of making paper may seem an unlikely investment choice for the e-age. But Kadant Inc. (NYSE: KAI), which makes the machinery that makes paper, also makes money. It beats pulp into cold hardboiled cash.

By grabbing overseas opportunities and establishing profitable acquisitions, Westford, Mass.-based Kadant has raised its earnings guidance for the year, and will end 2007 with plenty of financial flexibility. Barring a global slowdown, the company is expected to grow earnings 13% in 2008 as it continues to expand overseas—particularly in China—and retool aged equipment in North America.

Kadant’s technology-based systems prepare stock by recovering usable fiber from recycled materials and by preparing virgin fiber for entry into the paper machinery. It also sells paper machine accessories, as well as water-management systems that clean and condition papermaking fabrics. Its fluid-handling systems are used in the steel, rubber, plastics, food and textile industries.

Selling into the global pulp and paper industry, Kadant—in addition to China—is growing elsewhere in Asia and in Eastern Europe, concentrating on Russia. Although these are the key growth areas—Kadant does about 60% of its business overseas—there’s also demand in North America as companies upgrade systems to ease the impact of high energy prices.

“We believe (Kadant) continues to be on a growth track because of its strong position in China, as well as solid demand for its products that reduce energy and water usage,” Standard & Poor’s analysts said after third-quarter results were released in late October. Kadant will continue to grow in 2008 due to its solid presence in China, where significant new linerboard capacity is being added, S&P said.

Plus, high energy costs in North America are likely to boost demand for Kadant’s fluid handling products and software that improve dryer operations. S&P noted that the company is also working to boost sales of products outside the paper industry.

North America’s the sidekick; China’s the heavy. “Without question, China is currently the most important paper-producing region in the world, accounting for most of the global capacity expansion,” said CEO William Rainville said in the 2006 annual report.

And who’s to disagree? With economic growth comes the need for paper products ranging from linerboard to tissue. Global paper demand for paper and paperboard is expected to reach 490 million tons by 2020, up 37% from 2004; China, India and Russia are expected to account for 70% of that increase. Between 2005 and 2009, recycled-fiber papermaking capacity is expected to grow 24 million tons annually, with China adding two-thirds of that.

Kadant’s partaking. In the first nine months of this year, about 23% of the company’s $61 million in revenues came from China. Kadant expects to manufacture and source more of its equipment and accessory products in the country in the future.

Acquisitions are key to Kadant’s China plans. In 2005, the company acquired Kadant Johnson, with makes fluid handlings. This broadened Kadant’s offerings and expanded its customer base to include industries such as steel, textiles and plastics. Kadant Johnson also has a factory in China, adding to Kadant’s Asia presence and enabling it to manufacture accessories and water management systems in China.

In 2006, Kadant made another buy—Kadant Jining—which will add to its stock-preparation manufacturing capabilities in China.

“We’ve been encouraged by the pace at which Kadant has made headway extending its after-market sales into Asia,” J.P. Morgan analyst Claudia Shank said in a research note Nov. 12, after Kadant presented at a J.P. Morgan conference in late October. Kadant is J.P. Morgan’s top small-cap pick in paper and packaging sector.

Orders have perked up. In September, Kadant received a $13 million recycling system order from the Saigon Paper Corp. for its Ho Chi Minh City mill, to be delivered in mid-2008. At the same time, Kadant announced additional contracts with a combined value of over $22 million with an Asian customer for stock preparation systems for linerboard, and also has $11 million in recycling orders pending from paper and linerboard producers in Russia and China.

The orders resulted in a record backlog at the end of the third quarter through September, one that “remains favorable for continued healthy order flow in ’08, as capacity expansion--particularly in Asia--should remain robust,” said Shank.

For those who lust after cash flow—and who doesn’t?—lust no more. Kadant’s got the cash from operations to continue its solid performance. It says it will be debt-free in the next couple of quarters—perhaps as early as the end of 2007—giving it the financial flexibility to grow internally, repurchase shares and make additional acquisitions. Officials say they can accomplish these goals and still stay within a capital structure of 20% net debt to total equity.

Kadant may as well be printing money. EBITDA rose 73% to $37.2 million in 2006; in the first nine months of 2007, EBITDA totaled $32.3 million, up 14% from $28.4 million at the same time in 2006. “While we believe the company will continue to opportunistically repurchase shares, we also think focused acquisitions (within the paper industry) remain a priority and could drive further growth in 2008 and beyond,” said Shank.

Kadant’s diluted earnings per share from continuing operations rose 86% to $1.30 in 2006, including $0.04 of restructuring charges, and revenues from continuing operations rose by $98 million, or 40%, to a record high of $342 million.

Prospects for 2007 got better in late October when Kadant released third-quarter results. The company raised earnings guidance to between $1.66 and $1.69 per diluted share—including a $0.02 loss on the sale of a business—up from previous expectations of $1.49 to $1.59. It also expects 2007 revenues of $364 million to $366 million, up from a previous estimate of $360 million to $370 million. Fourth-quarter earnings are seen between $0.42 and $0.45 per diluted share on revenues of $94 million to $96 million.

Barrington Research analyst Michael Hutchison carries an “outperform” rating on Kadant, estimating earnings per share at $1.88 in 2008, up 13% from $1.68 this year. His price target is $38 per share, 20 times his 2008 earnings estimate. Kadant closed at $28.24 on Monday, suggesting plenty of upside from current levels. Over the last 52 weeks, shares of the small cap have ranged between $22.11 and $33.76.

Kadant (KAI) may lack the pizzazz of a hot new technology issue, but financially it is set to exploit hot new markets. Follow the money.

Disclosure: none

Source: Kadant Inc.: Pulp (and Papermaking) Non-Fiction