Q3 2024 Summary
Published Feb 5, 2025, 6:38 PM UTC- KMT's modernization has significantly enhanced its ability to innovate and release new products, particularly in coating technology, which is expected to drive market share gains. Since modernization, KMT has launched five product innovations, compared to a 7 to 8-year gap before modernization. This innovation advantage is a major driver for future growth.
- The unfavorable price/raw material timing effects that have impacted margins are expected to abate in Q4, improving the Infrastructure segment's profitability. Stability in tungsten prices could further enhance the cost structure into FY'25.
- KMT is on track to achieve $35 million in annual restructuring savings by the end of FY'24, with additional rollover benefits into FY'25. This ongoing restructuring program is expected to drive further cost reductions and margin expansion.
- Persistent Weakness in General Engineering Markets: General Engineering markets remain soft and stable at lower levels, with no significant recovery expected in the near term. Christopher Rossi noted that the Eurozone PMI has been below 50 for 21 months, indicating continued contraction, and similar conditions are observed in the US. This prolonged weakness could negatively impact Kennametal's sales growth.
- Lower Mining Activity Due to Reduced Coal Demand and Slower China Recovery: Mining activity was lower than expected due to reduced coal demand in the US, attributed to a milder winter, and a slower economic recovery in China. Additionally, construction activity in China is slowing down. These factors are negatively impacting Kennametal's Infrastructure segment.
- Margin Pressure in Metal Cutting Segment Due to Lower Volumes: The Metal Cutting segment experienced a 230 basis point decline in adjusted operating margins year-over-year, driven by lower sales and production volumes, and higher wages and general inflation. Adjustments to production levels and cost structures take time, suggesting that margins may continue to be under pressure.
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Market Outlook and Demand Trends
Q: Can you walk through major end markets and underlying trends?
A: The quarter unfolded as expected overall, but with some differences in end markets. General Engineering remained flat, with industrial activity soft in the Americas and EMEA, while Asia Pacific improved slightly. Aerospace deteriorated slightly due to quality issues at a major OEM, but long-term trends are very positive. Energy was flat, and we expect it to remain so into the fourth quarter. Transportation in the Americas is improving due to strike recovery and seasonality. Mining activity was lower than expected, driven by lower coal demand in the U.S. due to a milder winter and slower recovery in China. Looking ahead, we anticipate stable conditions at these softer levels. -
Share Buyback Program and Cash Flow
Q: What are your expectations for free operating cash flow and share repurchase plans?
A: Our strongest cash flow quarters are Q3 and Q4, and we anticipate strong free operating cash flow. We remain committed to returning cash to shareholders, recently concluding our first $200 million share repurchase program, and the Board has authorized a second 3-year, $200 million repurchase program starting in February. We'll balance buybacks with other potential uses of cash like bolt-on M&A and managing seasonal cash flow needs. -
Pricing and Raw Material Impact
Q: How will the price and raw material dynamics affect the Infrastructure segment?
A: We faced headwinds in prior quarters due to the lag between pricing and raw material costs, particularly tungsten. In Q4, this headwind will abate, with costs flowing through the P&L. Tungsten prices hit a recent low around $312-$313 per MTU but have risen to about $332-$333. If prices remain stable, we'll see more cost structure stability into the second quarter of FY'25. -
Seasonality and FY'25 Expectations
Q: Should we expect normal seasonality heading into next fiscal year?
A: Yes, we anticipate normal seasonality, with sales typically down 8%-10% from Q4 to Q1. As we plan for FY'25, we're considering factors like raw material costs—tungsten prices have stabilized—and the benefits from our restructuring program, aiming for a $35 million annual run rate. We'll provide a holistic outlook in about 90 days. -
Product Innovations and Growth
Q: How do new product contributions relate to growth and market share?
A: Modernization has enhanced our ability to release new products and take market share. We've released our fifth product innovation in coatings since modernization, whereas before it might have taken 7-8 years to release similar advancements. We expect 1%-2% growth from market share gains driven by innovation over the long term, with most of that growth still ahead of us. -
Aerospace & Defense Outlook
Q: Do you expect Aerospace & Defense to grow over the next few years?
A: Yes, we believe demand in aerospace is solid. While quality issues are inhibiting short-term demand and production build rates haven't returned to pre-pandemic levels, there's a definite need for more aircraft. Supply chain constraints are being addressed, and we feel positive about growth in the medium to long term. Our portfolio is mostly commercial aerospace, with some defense. -
Customer Inventory Levels
Q: Are customer inventory levels reflective of stable or softer demand?
A: Customers are cautious with inventory levels, reflecting the current stable but softer demand conditions. We don't anticipate significant destocking ahead, and customers are likely to await stronger demand signals before restocking. -
Metal Cutting Margins and Volume Sensitivity
Q: What impacted Metal Cutting margins this quarter?
A: There was a prior year $1 million gain from a property sale that didn't repeat. Additionally, we saw a slowdown in markets in December, leading to negative volumes despite positive pricing. Adjusting production and cost structures to match demand takes time, which impacted margins in the quarter. -
Demand Trends Outside China
Q: Have you seen changes in demand patterns beyond China?
A: In General Engineering, demand remains stable at softer levels. The Eurozone PMI has been below 50 for 21 months, hovering between 45 and 50. The U.S. is also in contraction territory but stabilizing. Recent upticks in industrial production indices are noted but not yet indicative of a trend.