2023-05-05 15:35:42 ET
Summary
- Following Kimball Electronics, Inc.'s 8 years as a public company since the spinoff from Kimball International, Inc., growth is now accelerating, but the stock remains cheap at less than 9x forward earnings.
- Demand for products and services in automotive, medical, and industrial markets is growing, and Kimball Electronics is expanding to meet the growing demand.
- A new CEO is taking over who has an opportunity to expand market share and leverage existing customers to fuel the growth ahead.
As we approach the halfway mark to 2023, some pundits and financial gurus may tell you that the best plan is to sell in May and go away. Then return to the market in the fall when the institutional investors are back in full swing after the summer lull. But if you take their advice, you may miss out on some excellent opportunities that are currently being offered in several growth stocks that I follow, most of which are currently down in price due to recent bearish sentiment. If you believe, as I do, that we are simply embroiled in a volatile bull market that is recovering from the beating it took in 2022, although swinging wildly at times, then you may want to stay invested and take advantage of price swings on some solid growth names.
I am seeing opportunities in several different industries and sectors that range from healthcare and hospitality to technology and industrials. I cannot cover all the names that I am following in one article, so I am planning to do a brief series with one company that you may not be familiar with in this first article, just to whet your appetite. Then I will publish a few more articles on other growth stocks that I am following when I find the time to work on those. In this first edition for growth stocks that I feel are well positioned heading into the second half of 2023 and beyond, I would like to cover one that does not get a lot of attention from analysts on SA.
The first company that I would like to highlight is Kimball Electronics, Inc. (KE). Kimball is an electronics manufacturer that primarily serves automotive, medical, and industrial markets. They are a global multifaceted manufacturing solutions provider with a reputation for excellence, at least according to their website . Like other companies that I have previously covered , including Powell Industries, Inc. (POWL), KE is a growth stock for the 4 th Industrial Revolution, leveraging Industry 4.0 trends to grow their business and generate increasing earnings as they work to improve people’s safety, comfort, health, and productivity.
The quant ratings for KE indicate a B+ for Growth and an A for Valuation. SA Analysts, Wall Street analysts, and the SA Quant system all rate KE a Buy or Strong Buy. After their most recent earnings report (which I will discuss in more detail below), I rate KE a Strong Buy at the current price. The most recent coverage in February rated the stock a Buy at the price of $25.71. The stock has declined by more than -22% since then and I feel that it is now on sale at around $20.
Seeking Alpha
The recent history of revenue and earnings growth speaks to the gains being made by the company over the past several years as the lasting relationships with their customers have resulted in repeat business and increasing demand. The company offers electronics manufacturing services; diversified contract manufacturing services; automation, test, and measurement equipment; and engineering and design services.
In their 2022 Annual Report , which they titled Poised for Growth , the company reports a revenue mix of about 43% Automotive, 23% Industrial, 29% Medical, and 4% Public Safety with about 1% Other. About 80% of the revenues in the fiscal year 2022 came from existing customers they have done business with for over 10 years, and they were recognized by Forbes in 2021 as one of America’s Best Small Businesses.
Fiscal year 2022 was a good year for our company. While the world continued to experience unprecedented events and circumstances, we embraced an ever-changing global landscape with commitment and resolve, engaging in customer collaboration at levels even higher than our award-winning norm. Our strong customer partnerships produced several business wins, along with expansions of existing programs, that have us Poised for Growth as we look forward.
In January 2023 the company announced that a new CEO, Richard ((RIC)) D. Phillips, would take over from former Chairman and CEO Donald D. Charron who retired as of February 28, 2023, after 24 years, including since the company spun off from Kimball International in 2014. Under Charron’s tenure, KE grew from a division of its parent company to a global enterprise that is approaching $2 billion in annual revenues.
2023 Quarterly Reports
The fiscal 2 nd quarter of 2023 ended December 31, 2022, and results were reported on February 6, 2023. The press release from that report indicates that net sales for the quarter of $436.7 million was an all-time quarterly high and a YOY increase of 39%. Net income of $10.7 million or $0.43 per diluted share compared to net income of $5.1 million, or $0.20 per diluted share in Q222. So net income more than doubled in that one year period, while revenues increased by nearly 40%. At the same time, the company raised the outlook for the remainder of the 2023 fiscal year to a range of $1.7-$1.8 billion (from the previous range of $1.6-$1.7B) as they work down the backorder of post-pandemic supply chain disruptions.
Today on May 4, Kimball reported FQ3 2023 results and once again reported a record quarter for net sales with $484.7 million, up 32% YOY. Net income of $16.4 million, or $0.65 per diluted share compared to $13.6 million, or $0.54 per diluted share in Q322. The new CEO summed up the results for the quarter:
“I am very pleased with my first quarter as CEO of Kimball Electronics, and the opportunity to share strong results for Q3. The Company has been on a path of unprecedented growth, and for the fifth consecutive quarter, revenue reached an all-time record high. Throughout this journey, operating margin has improved as we ramp-up new and existing programs, and leverage our recent facility expansions in Thailand and Mexico. While the macro environment remains challenging, we are forecasting a solid finish in the fourth quarter, and we are updating our outlook for fiscal year 2023, with sales expected at the high-end and adjusted operating margin in the mid-to-low end of our guidance range.”
The revenue mix was tilted slightly more toward the automotive market in Q3 as shown on the earnings release . The change in revenues from the previous year’s reporting period included a 34% increase in the automotive segment, with a 30% increase in medical and a 29% increase in the industrial segment.
As the electric vehicle ("EV") market picks up speed again, there is likely to be further demand and growth opportunities globally for KE to address that expanding market. Also, as post-pandemic supply chain disruptions (e.g., chips for autos) work their way through the various systems, I would expect this segment to experience even more growth in the future.
Balance Sheet And Capital Allocation Strategy
In FY22, the company doubled its credit facility with their banking partners from $150 million to $300 million with an amended 5-year revolving credit facility to fund capital expansion and working capital needs, including cash for acquisitions as appropriate. Over the past 7 years, the company has made $50 million in acquisitions.
On the company’s website where they explain Why Invest, they outline their capital allocation strategy:
Deployed a capital allocation strategy that included investing in future growth with expansions at multiple facilities, returning cash to Share Owners in the form of stock repurchases, and supporting our customers with strategic inventory builds to mitigate parts shortages, even though the increases adversely impacted certain financial metrics including cash flow, Cash Conversion Days ((CCD)), and Return on Invested Capital ((ROIC)). We fully expect improvement in these areas as conditions normalize in the global supply chain.
They spent $24.7 million on capital expenditures in Q3, including expansion of facilities in Thailand and Mexico, with plans to spend a total of $80 to $100 million on CapEx in FY23. They reported $30M in cash and $289M in outstanding credit available as of March 31, 2023, including $98M in available borrowing capacity. As of the end of FY22, the company had repurchased a total of $88.8 million in common shares since 2015.
Valuation
While the stock currently trades at a forward multiple of less than 10, the expectations for future earnings growth indicate that the stock is incredibly undervalued if the growth can continue at the expected rate. According to annual EPS estimates on SA, the forward P/E for KE as of June 2023 is around 9x earnings and only about 7.5x earnings for 2024.
These estimates are based on only 2 analysts following the stock, and if the recent revenue growth experienced over the past several quarters continues into the future, those estimates are likely to be very conservative and will probably be revised upward giving the stock an even better valuation.
The share price has seen little movement over the past year with most of the gains from 2022 given up in the past few months. I believe that trend is likely to reverse as investors realize just how undervalued the stock is at the current price below $20.
A more reasonable forward multiple for a growth stock in this category is closer to 12 to 14 times earnings, which is also closer to the historical average for KE over the past 5 years.
If the analyst estimates of around $2.20 in EPS for 2023 is accurate, that results in a target price of $26.40 to $30.80 in 2023. That would represent an upside of as much as 50% from the current price. If the company earns $2.50 in 2024 (the low end of analyst estimates) at a multiple of 14x earnings, the 2024 target price would be $35. That is if one is to assume that earnings do not continue to increase into the next few quarters. My expectation is that the earnings will continue to grow as revenue growth continues while the company executes the capital allocation strategy that they outlined.
Risks To Consider
Kimball Electronics is a small company with a market cap of just over $500M and trades on relatively light volume, which means it may be subject to volatility in the share price. That volatility has resulted in what I consider to be an excellent opportunity for long-term investors should the thesis play out that growth is likely to continue. However, other factors including macroeconomic and geopolitical events could derail the global growth story, especially if the conflict in Ukraine rages on or expands into neighboring countries, or if China or some other rogue nation decides to stir things up. Inflationary pressures may also continue to hamper demand for electronics and if the recession that everyone expects actually shows up in the next few months, that could obviously have a detrimental effect on the growth story.
In addition, there is the new CEO, Ric Phillips, who has been on the job for less than 3 months so far. He officially took over the reins on March 1, 2023, so it remains to be seen what impact he will have on the operations and growth plans. He does have over 20 years' experience including former President and CEO of two previous companies (Elkay Manufacturing and Essendant) as well as leadership roles with McKinsey & Company.
Competition from other electronics manufacturers could be another risk to consider. Looking at Peers on SA, the closest company that matches up with KE based on market cap, number of employees, annual revenues, and other criteria is Benchmark Electronics, Inc. (BHE). They just reported Q1 results with guidance in line and GAAP EPS of $0.46 with 9% YOY revenue growth. KE has far better 1-year, 3-year, and 5-year total returns.
Concluding Remarks
While the annual report for Kimball Electronics, Inc. explains why they believe that they are “poised for growth,” it is my belief that the market has not yet realized the growth potential that exists with this company. The new CEO has a fantastic opportunity to take over a well-oiled machine with a solid reputation and the groundwork laid for future expansion. If all goes according to plan, Kimball Electronics, Inc. will soon recognize revenues exceeding $2 billion annually. With a significant addressable global market that is growing in all 3 market segments that they specialize in, the potential is there for this company’s stock to take off in the near future.
At a very inexpensive valuation of less than 10 times forward earnings for 2023 and 40% revenue growth over the past year despite difficult macroeconomic conditions, Kimball Electronics, Inc. stock is a Strong Buy at a price below $20 and a Buy up to $25 for investors with a long-term horizon of 5 years or more. I do not currently own Kimball Electronics, Inc. stock, but I may decide to purchase some shares before the market wakes up and realizes that it is missing out on an excellent growth story that looks very likely to continue for the foreseeable future.
For further details see:
Kimball Electronics: One Growth Stock To Consider For A Second-Half Recovery