FN - Kimball Electronics: An Attractive Play On Booming Sales Improving Cash Flows

Summary

• Kimball Electronics has generally fared well from a sales perspective, but bottom line results have been volatile from year to year.
• 2023 is certainly looking up for the company, with sales soaring and most bottom line results coming in stronger than they were a year earlier.
• The stock is also cheap, both on an absolute basis and relative to similar firms.

As the global economy has grown larger, specialization has become a facet of many different industries. In an effort to keep costs down, firms that once used to produce everything that they sold have shifted focus and have moved in the direction of finding firms that are specialized that can produce the same product at a lower cost. One of the businesses that provides these types of services when it comes to electronics manufacturing, as well as other specialized manufacturing activities, is Kimball Electronics ( KE ). In recent years, the overall trend in terms of sales for the company has been positive. Profits and cash flows have been a bit lumpy. But all things considered, the picture is decent from a fundamental perspective. Add on top of this the fact that shares of the business look cheap, both on an absolute basis and relative to similar firms, and I would make the case that this enterprise is a reasonable soft ‘buy’ candidate for long-oriented investors.

A specialty provider

According to the management team at Kimball Electronics, the company operates as a global manufacturing solutions provider of contract electronics manufacturing services. It also engages in diversified manufacturing services, such as engineering and supply chain support, to customers across a wide array of industries. Examples here include the automotive, medical, industrial, and public safety end markets. Outside of the electronics category, Kimball Electronics also provides manufacturing services for non-electronic components, medical disposables, drug delivery solutions, precision molded plastics, test and inspection equipment, and more. Examples of its work in the automotive space include electronic power steering systems and vehicle sensors.

If it sounds like this type of business would not make sense to exist, management made clear that there are several benefits to the services they offer over what you might get with and go at your own approach. Since the company works with countless customers, it's able to engage in central sourcing activities that empower it to leverage the purchase volume of the entire organization when making procurement decisions. As an example, If the enterprise needs to produce different products for different customers that all utilize the same sort of metal, they can source the metal together and, because of purchasing power, negotiate more attractive prices than what a smaller manufacturer might be able to achieve.

Outside of the manufacturing itself, the company provides a wide array of other services. For instance, it helps with design activities. I already mentioned supply chain services. It also assists with rapid prototyping, reliability testing, software design, and more. The firm's reach also expands into various niche areas such as code chain and product sterilization management, the production and distribution of drug delivery services and solutions, the production and testing of printed circuit board assemblies, and more.

Over the past five fiscal years, the overall picture for the company has been fairly solid from a revenue perspective. Sales increased in each of the past five years, climbing from $1.07 billion in 2018 to $1.35 billion in 2022. The 4.5% year-over-year increase that the company experienced from 2021 to 2022 was driven by improved revenue associated with multiple vertical markets. Sales associated with the automotive space, for instance, grew by 5.6%, climbing from $551.5 million to $582.2 million. Management attributed this increase largely to the ramping up of certain programs and new product introductions. These included programs for fully electric vehicles and came in spite of an unfavorable impact associated with component shortages. The industrial market was responsible for a 4.9% increase in sales from $293.7 million to $308.1 million. This, according to management, was largely due to higher demand for climate control products. In addition, the ‘other’ category for the company, which consists of all miscellaneous activities that it engages in, spiked 27%. But that was from a very low base of $13.7 million to a still-low $17.4 million. Other categories posted slower growth. Public safety, for instance, rose by only 4.2%, while the medical space resulted in a 1.8% rise.

On the bottom line, the picture for the company has been a bit different. Instead of seeing a consistent uptrend like what we saw when looking at revenue, the firm experienced some rather volatile earnings. After bouncing around between $16.8 million and $31.6 million in the three years ending in 2020, profits spiked to $56.8 million in 2021 before dipping back down to $31.3 million in 2022. Operating cash flow has seen even greater volatility, bouncing around between negative $6.7 million and positive $130.1 million in the four years ending in 2021. In 2022, however, cash outflows came in at $83.2 million. If we adjust for changes in working capital, at least we do see some consistency. This much can be seen in the original chart in this article. That same kind of consistency can be seen when looking at EBITDA as well.

When it comes to the 2023 fiscal year, mixed results have continued. On the positive side, revenue for the company spiked from $608 million in the first two quarters of 2022 to $842.6 million in the first half of 2023. Growth here was broad-based, with every major vertical market reported by management seeing a nice move higher year over year. With the exception of the ‘other’ category, where sales shot up 76% from $7.2 million to $12.7 million, the greatest increase came from the automotive space. Revenue here was up 43.3%, rising from $268.4 million to $384.5 million. Management attributed this to the ramping up of certain programs, new product launches, and greater component availability as supply chain issues showed signs of improvement. Revenue in the medical category, meanwhile, rose by 37% from $174.8 million to $239.5 million. This increase, management said, was due to the same reasons but, obviously, for different types of products, as for the automotive market. Industrial revenue (which, effective for the 2023 fiscal year, included the public safety category as well), meanwhile, rose 30.6% from $157.6 million to $205.9 million., thanks largely to improved component availability and high demand for climate control products.

This spike in revenue brought with it a rise in profits. Net income nearly tripled from $7.7 million to $20.2 million. On the other hand, operating cash flow worsened from negative $56.5 million to negative $71.9 million. If we adjust for changes in working capital, however, we would have seen an improvement from $26.8 million to $35.6 million. And finally, EBITDA for the business expanded from $26.9 million to $49.2 million.

For 2023 in its entirety, Kimball Electronics anticipates revenue of between $1.7 billion and $1.8 billion. In addition to translating to a year-over-year growth rate of between 26% and 33%, it's also higher than the prior expected range of between $1.6 billion and $1.7 billion. Management did not give any guidance when it came to net profits. But the operating income margin that they said they are targeting would translate to operating income that is decidedly higher than what the company saw during its 2022 fiscal year. If we apply that to the firm's other profitability metrics, we would anticipate adjusted operating cash flow of $113.7 million and EBITDA of $139 million.

Based on these figures, Kimball Electronics is trading at a forward price to adjusted operating cash flow multiple of 5.8 and at a forward EV to EBITDA multiple of 6.5. By comparison, if we were to use the data from 2022, these multiples would be 9.4 and 10.6, respectively. And if we were to use the data from 2021, the multiples would be 7.3 and 8.9, respectively. As part of my analysis, I also compared the company to five similar firms. I did this relative to the 2022 readings. On a price to operating cash flow basis, these companies ranged from a low of 10.4 to a high of 61.9. In this case, Kimball Electronics was the cheapest of the group. Meanwhile, using the EV to EBITDA approach, the range was from 6.9 to 67.4. In this case, only one of the five companies was cheaper than our target.

Takeaway

Although bottom line results for Kimball Electronics happened somewhat lackluster in recent years, that picture is showing significant improvement for the 2023 fiscal year. Sales are also growing nicely, even outpacing the consistent growth that the business experienced in prior years. On a forward basis, shares in the company look incredibly cheap. But even if we were lonely on multiples that use data from the 2022 fiscal year, the stock still looks very affordable, both on an absolute basis and relative to similar firms. Given all of these considerations, I do believe that it makes for a solid ‘buy’ prospect at this time.

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