S&P Downgrades Kennametal (KMT) to 'BBB-'; Outlook is Stable

August 29, 2016 7:55 AM EDT

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S&P Global Ratings said that it has downgraded Kennametal Inc. (NYSE: KMT) to 'BBB-' from 'BBB'. The outlook is stable.

At the same time, we lowered our issue-level ratings on the company's senior unsecured debt to 'BBB-' from 'BBB'.

"The downgrade reflects our expectation that the weak conditions in Kennametal's energy, earthworks, and general engineering end markets (71% of its total sales) will persist in the near-term, making it unlikely that the company's credit measures will quickly recover to levels that are commensurate with a 'BBB' rating," said S&P Global credit analyst James Siahaan. Kennametal's operating performance deteriorated meaningfully during the fiscal year ended June 30, 2016. Specifically, the company's sales declined by over 20% during the past year largely due to declining order volumes, along with the negative impact from its recent divestitures and foreign-currency headwinds. While some of Kennametal's customers have already drawn down their inventories, we still forecast that the company's sales will contract by the low-single digit percent area in fiscal-year 2017. In addition, despite our expectation that the company will achieve some cost savings and improve its EBITDA margins, we now assess Kennametal's business risk profile as being at the weaker end of our satisfactory category. This reflects that the company has lagged behind its competitors whose businesses have broader scale and higher operating margins. We now choose to assign the lower of our two initial analytical outcomes to the company to reflect its weaker-positioned business risk profile.

The stable outlook on Kennametal reflects our belief that the company's mining and energy end markets will stabilize somewhat during the fiscal year ending June 30, 2017, and that the company will achieve significant cost savings from its restructuring activities. We view an adjusted debt-to-EBITDA metric of less than 3x and a free operating cash flow-to-debt ratio of greater than 15% as appropriate for the current rating. While the company's debt-to-EBITDA metric may become somewhat stretched in 2017, we expect it that it will improve over time.

We could lower our ratings on Kennametal if protracted weakness in the company's key markets or an inability to improve its margins as expected causes its adjusted debt-to-EBITDA metric to remain above 3x and its free operating cash flow-to-debt ratio to remain below 15% without clear prospects for improvement. This could also occur because of a large, unexpected debt-financed acquisition or shareholder initiative. We could also lower the ratings if the company's scale and the scope of its operations weaken materially.

While unlikely in the near-term, we could raise our ratings on Kennametal if lower costs and improved productivity cause its profit margins to improve to more than 16% on a consistent basis while the scale, scope, and diversity of its operations meaningfully improve. A higher rating would also be dependent on the company maintaining a total adjusted debt-to-EBITDA metric of consistently below 2.5x while committing to follow conservative financial policies.

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