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Kadant Inc: Net Cash of $40 Million with $20 Million in Potential Buybacks

December 18, 2012 | About:
Kadant Inc. (KAI) is a leading supplier to the global pulp and paper industry. Its stock-preparation, fluid-handling, doctoring, cleaning and filtration equipment and systems are designed to increase efficiency and improve quality in pulp and paper production. Many of KAI's products, particularly in its fluid-handling product line, are also used to optimize production in other process industries. In addition, it produces granules from paper-making byproducts for agricultural and lawn and garden applications. KAI is based in Westford, Mass., and has approximately 1,700 employees in 17 countries worldwide, with major operations in North and South America, Europe and Asia.

Valuation and Financial AnalysisKAI is currently trading at a trailing 12 months P/E of 9.20 and a trailing 12 months EV/EBITDA of 5.27. KAI achieved a ROE of 13.9% for the past 12 months and a five-year average ROE of 4.5%. KAI generated positive free cash flow in every single year for the past decade, but experienced losses in 2008 and 2009. This could be partly attributed to customer requests to delay deliveries of previously-ordered equipment, resulting in KAI being unable to recognize revenue for certain capital orders in China using the completed contract method.

KAI Earnings-Cash Flow Comparison

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KAI Profit Margins Analysis1355827052179.png

Business and Financial Risks

KAI has a strong balance sheet in the form of a net cash financial position with a very low gross debt-to-equity ratio of 5%. Net cash of $41.5 million on the books represented 14% of KAI's current market capitalization of $289 million. KAI has bookings and backlogs amounting to $69.3 million and $78.6 million as at Sept. 30, 2012.

KAI Cash-Debt-Market Capitalization Comparison1355827101246.png

An unexpected increase in the prices of KAI's raw materials such as steel, stainless steel, brass and bronze may impact its margins negatively, if it is unable to offset the effect of these increased costs through price increases, cost reduction programs or productivity improvements. KAI is also dependent on two paper mills for the fiber used in the manufacture of its fiber-based granular products and has experienced difficulty in obtaining sufficient raw material to operate at optimal production levels from time to time.

KAI faces unique risks in China, where it derives a significant portion of its international sales. Larger paper producers in China have delayed, and may in the future delay, additional new capacity start-ups and the delivery of previously-ordered equipment in response to weaker market conditions. This could have a negative impact on KAI's bookings and revenues in China. In addition, large stock-preparation systems tailored to customers' specific requirements exposes KAI to significant credit risk and it also experienced delays in the receipt of payments and letters of credit

KAI may be unable to adjust its China operations to meet demand, given that demand for its products in China can vary significantly from period to period. For example, KAI experienced lower bookings levels in the second half of 2011, after a large increase in demand for its stock-preparation products in China in late 2010 and early 2011. In periods of lower demand, KAI needs to act swiftly to consolidate production or lay off workers in its manufacturing plants in China. In periods of higher demand, KAI may need to shift to higher-cost production facilities outside China and hire additional workers, or face contractual penalties if it is unable to meet the increased demand from customers.

Business Quality and Capital Allocation

KAI leverages its low-cost manufacturing operations in locations such as China. It engaged in the modernization of its manufacturing facilities and made significant investments in new equipment in 2011 to improve its operational efficiencies. It also launched several new products for global distribution from its China operations, including its new FibreWall screen cylinder, which features a distinctive design and manufacturing process that increases screening performance and reliability for its customers.

KAI is well-diversified across geography and product lines. North America, Europe and China accounted for 44%, 25% and 19% of KAI's 2011 sales, respectively; while stock-preparation, fluid-handling and doctoring, cleaning & filtration was each responsible for approximately for one-third of its sales in 2011.

KAI has one of the largest installed base of equipment in the pulp and paper industry, providing it with a spare parts and consumables business that yields higher margins than its capital equipment business. Higher mill operating rates also led to an increased demand for its spare parts and consumables products.

On Oct. 29, 2012, KAI's board of directors approved the repurchase up to $20 million of its equity securities, equivalent to 7% of its current market capitalization during the period from Nov. 7, 2012 to Nov. 7, 2013. As of Sept. 29, 2012, KAI had repurchased 669,725 shares of its common stock for $14.6 million under the previous share repurchase authorization in October 2011.

Conclusion

Share buybacks are quite different from dividends, since there is no certainty as to the timing and amount of capital return. More importantly, some companies do not have sufficient cash to execute the share buybacks and borrow to buy back shares, effecting its own version of a 'carry trade'. This is not likely to happen with KAI, which has net cash double the amount of its share repurchase authorization.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


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