A. O. Smith Corporation (AOS), Kaydon Corporation (KDN), Kennametal Inc. (KMT): One Multi-Industry Name to Buy, Two to Hold

A. O. Smith CorporationThe earnings season is on a roll and some results have come with big surprises for investors. Amid all of these surprises, however, some industries have failed to attract investors given the lesser volatility in their results. The multi-industry space has been one of them.

Is it true that multi-industry players are not worth a look? Let’s have a look at earnings reviews of some of the players in this space.

Earnings Reviews

A. O. Smith Corporation (NYSE:AOS)’s performance during the second quarter of 2013 was relatively solid given the continued improvements in the US market alongside solid performance in China during the quarter. Although issues regarding the availability of credit in China have begun to creep in, this was not appropriately reflected in the company’s guidance for 2013. The company now expects its earnings per share to improve to a range of $1.84 – $1.90, a 20% increase from its 2012 levels.

In the US, April water heater statistics (the most recently available) had already given a hint of a strong start to the second quarter as residential water heater installations were up 27% while commercial units increased 17%. This follows 7% and 15% growth in the first quarter for residential and commercial units respectively.

In terms of operating margins, the company posted a margin of 11.8% that highlighted an increase of 110 basis points (on a year-over-year basis) due to gains in its North America and Rest of the World segments. While this was a material improvement when compared to results for the previous year, this was slightly down from the first quarter’s adjusted operating margin; this was primarily due to lower commercial water heater sales as a percentage of the mix. The second quarter’s performance experienced some modest operating inefficiencies which impacted earnings before interest and tax by $4 million.

Many analysts keenly listened to the company’s commentary on China. The company announced that it expects an 18% growth in revenues from China. Given the terrific figures for the first half of the year in this region, however, it can be easily inferred that the growth will decline to the low double digits in the second half of the year as a result of tighter housing regulations introduced by the local government.

Another beat

The very next day, Kaydon Corporation (NYSE:KDN), another multi-industry player, reported earnings results that topped the estimates. This came as a surprise for bears that had expected the company to miss its earnings on the basis of headwinds in Europe, power generation and the heavy equipment business.

Cash generation remains a focus for investors. As Kaydon Corporation (NYSE:KDN)’s primary means of capital redeployment has been for dividends (currently paying a dividend yield of 2.76%), any indication of future dividend policy changes would boost clarity and be well received by the investment community. The company’s free cash flow status improved in this quarter as FCF/revenues came out to be 16%, as compared to 11% in the same quarter previous year.

Merger and acquisition activity is likely on hold for the company in the near-term. Given the company’s modest debt levels (20% net debt/total capital) and limited changes in the M&A environment since the first quarter, the Street does not expect any indications of M&A activity from Kaydon Corporation (NYSE:KDN).

Overall, the stock looks to be an expensive one given that it is trading at a forward multiple of 15 times. The company’s stock is up 24% since the start of the year. The stock has recently been downgraded by Goldman Sachs, showing the negative sentiment that the market holds for the company.

A hat-trick of earnings beats

Kennametal Inc. (NYSE:KMT), the manufacturer of metalworking tools and solutions, reported its results on Jul 26. The company, like its peers, topped the earnings per share estimates as the company reported earnings per share of $0.76, which was $0.02 more than the estimates. Given that this was the last quarter of the company’s financial year, investors were curious about its guidance for the next financial year.

For the 2014 fiscal year, the company’s guidance reflects organic top line growth of 5% to 7%, which is approximately 2 times the previously-forecasted industrial production growth of 3.3%. The company is also expected to continue to generate strong cash flows and will remain consistent with the capital allocation strategy.

The valuations seem cheap for the stock. The stock trades below an average multiple of 11 times. This discounted multiple may be attributed to the inventory management issues that the company has been facing lately. During its earnings call, the company indicated an inventory reduction of $41 million for the year, which fell short of $60 million target that the company had stated at the start of the fiscal year.

Given that the stock has climbed 7% since the start of the year (as compared to S&P 500 being up 20%), it seems that most of these issues have already been baked in the stock prices. The bulls have reasons to be bullish on the company – A recovery in infrastructure remains around the corner. It also has a solid share repurchase program under its belt.

Final word

Those who say multi-industry stocks hardly move have not understood or followed this space properly. This space has been the most exciting in context of merger and acquisition activity, dividend hikes and share repurchases. This has helped stocks of companies like A. O. Smith Corporation (NYSE:AOS) and Kaydon Corporation (NYSE:KDN) to beat the market. However, there have also been companies like Kennametal Inc. (NYSE:KMT) that have not climbed the ladder as quickly as their peers and hence pose a good investment opportunity.

The article One Multi-Industry Name to Buy, Two to Hold originally appeared on Fool.com and is written by Zain Abbas.

Zain Abbas has no position in any stocks mentioned. The Motley Fool recommends Kennametal. Zain is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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