This aerospace company beat earnings estimates by $0.20 last quarter. The shares have a current annual dividend yield of 2.24%, paid quarterly.
Kaman Corporation (KAMN)
From Cabot Turnaround Letter
Kaman Corporation is a defense and aerospace company that produces highly-engineered components, specialty fuzes (mechanical fuses) for missiles, and various assemblies. Founded in 1945 by aviation pioneer Charles Kaman, the Connecticut-based company was originally an innovative and successful maker of military helicopters. Over time, it leveraged its in-house technology to produce specialty bearings, materials, and other advanced components for manufacturers in the commercial aerospace, medical and other industries. Today, about 52% of its sales, of which fuzes are more than half, are to the defense industry. Commercial markets generate 48% of total sales, with Boeing providing an estimated 18% of total sales while other aerospace, medical and industrial customers comprise the rest of commercial revenues. Kaman maintains a global manufacturing footprint, as about half of its sales are to non-U.S. customers.
Kaman’s shares have declined 50% from their early 2018 peak and now trade essentially unchanged from their 2007 price and their pandemic low. Part of the reason is the company’s reliance on Boeing, which suspended production of the 737MAX in 2018 and then suffered from order cancellations and reduced demand due to the pandemic. Kaman’s shares have declined 35% since early June, coinciding with the sell-off in airline stocks related to renewed Covid concerns. Also, Kaman’s Joint Programmable Fuzes (JPF) program has shrunk over the past few years and is increasingly at risk of being replaced by a competitor, further weighing on the shares.
More generally, the value of Kaman’s highly-engineered product operations is being obscured by peripheral and likely low-margin businesses, such as military aircraft wing and cockpit assembly. The K-MAX helicopter, may have interesting potential but appears to be an expensive distraction that further hides the precision engineering group’s value. Kaman breaks out segment revenues but doesn’t share segment profits, so investors have little ability to accurately assess exactly where and how much value is being created, or destroyed, and so the shares get a discount for this lack of transparency.
With investors seeing Kaman as little more than a low-margin aerospace contractor tied to the soft commercial jet market and a fading JPF program, perhaps it’s not a surprise that they have thrown in the towel.
Kaman’s board of directors appears to be ready for a new direction. This past year, the nine-person board was reduced to eight members, installed a new lead independent director, and replaced three members with well-qualified executives. In September 2020, the company hired a new CEO, Ian Walsh, who previously was CEO at REV Group, held senior leadership roles at Textron, and is a former Marine Corps officer. Walsh recently promoted a new CFO, and has hired several key senior executives from Textron. It appears that he is importing many of Textron’s impressive processes to Kaman – likely bringing more efficiency, effectiveness and speed—through the new Operations Excellence initiative. Kaman’s heightened willingness to improve disclosures should help investors understand the company better, which should boost the shares’ valuation.
Walsh has stated clearly that he prioritizes the highly-engineered products segment over the others. He is accelerating the company’s internal innovation pace, and is likely to use some of Kaman’s sturdy balance sheet to acquire similar companies. Also, top priorities: generating higher margins, stronger free cash flow and better returns on capital, as well as returning cash to shareholders. Implicit in his strategy appears to be selective divestiture of low-margin businesses.
Even as investors have somewhat written off the entire JPF fuze business as sales to the U.S. government may fade away after the recently-extended contracts expire in 2023, the international customer base is sizeable and appears more enduring.
Recent financial results have been encouraging. Organic sales in the second quarter grew 5.4% and profit margins showed strong expansion. The company reduced its full-year revenue guidance, but this may be a positive as it is largely due to weakness in low-margin businesses. Guidance for profits was increased. The outlook for next year is for more commercial aerospace recovery and continued strength in the medical and industrial segments.
Kaman should generate positive free cash flow this year. Its balance sheet is sturdy and underleveraged with only $187 million in debt (about 2x EBITDA), and $98 million in cash. Investors should anticipate that acquisitions could temporarily raise leverage to about 3.5x. Helping to reduce its liabilities: Kaman froze its defined benefit pension plan and is making $10 million annual contributions to whittle away the remaining obligations.
Like all defense contractors, many of Kaman’s businesses are subject to its customers’ changing priorities and budgets. Yet, it seems like the world is becoming a more dangerous place with an increasing need for better-armed militaries.
Trading at a modest 9.8x next year’s EBITDA, and providing a 2.1% dividend yield, Kaman shares look attractive for patient investors.
We recommend the purchase of Kaman Corporation shares with a 57 price target.
Bruce Kaser, Cabot Turnaround Letter, cabotwealth.com, 978-745-5532, October 27, 2021