Wind at Its Back
BY JIM MCTAGUE
IT TAKES MORE THAN WIND TO MAKE A WIND turbine go 'round. You also need a good set of ball bearings, and that's where Kaydon Corp. comes in. At a time when the rapidly growing wind-energy industry is beset by a parts shortage, Ann Arbor, Mich.-based Kaydon has the goods and is set to expand further in the field.
Kaydon (ticker: KDN), with a stock-market value of about $1.6 billion, supplies high-margin specialty parts like bearings and springs to sectors including defense, commercial aerospace, electronics and medical equipment. Its growth in wind energy is especially intriguing because some experts see that source providing more of America's energy by 2015 -- maybe not the 20% that the truest believers expect, but much more than the current 1%.
To make the most of that, Kaydon has just spent $60 million to expand its wind-turbine parts plant in Monterrey, Mexico. Sales of wind-turbine parts, mostly bearings, could zoom from $20 million now -- about 5% of Kaydon's total 2006 revenue of $404 million -- to $100 million by the end of the decade, says Ned Armstrong, an analyst with Friedman, Billings, Ramsey.
Such prospects help explain why investors have been bidding up Kaydon's shares. The stock, at a recent 55, is up more than 28% since Barron's mentioned the company's charms in a Feb. 19 story about rival bearing-maker Timken (TKR). But Kaydon's shares still are reasonably priced at 19 times 2007 expected earnings of $77 million, or $2.38 a share, after backing out the company's cash hoard of $375 million. Bulls see the stock headed as high as 66 in the next 12 months, and it could go considerably higher after that. Analysts are forecasting 2008 earnings of $2.75 a share.
As makers of wind turbines scramble for enough parts to keep pace with demand, Kaydon is doing a brisk business in ring bearings.
A new president and CEO, Jim O'Leary, is the source for much of the excitement surrounding the stock. The board hired O'Leary in March from Beazer Homes USA (BZH), where he was chief financial officer, to replace Brian Campbell, specifically because it wanted someone with a fresh perspective on capital allocation. (O'Leary says he's not a target of the FBI and SEC investigations into Beazer's mortgage-making activities in North Carolina.)
The new CEO is looking at possible acquisitions every day, he says. And with analysts projecting a growth in Kaydon's cash holdings of as much as 15% a year, he's also weighing enhanced dividends and stock repurchases.
Cash is just one of the balance sheet's strong points. Despite $200 million in long-term debt on its books, the company effectively has a debt-to-capital ratio of zero. That's because the debt is in the form of in-the-money convertible bonds, which will be turned into equity by May 30, 2008, explains Steve Barger, who follows Kaydon for Keybanc Capital Markets in Cleveland. Although that will increase shares outstanding from 28.29 million to about 35.2 million, Barger and other analysts already use the latter number when calculating per-share returns.
If O'Leary ultimately leverages up to a 30% debt-to-capital ratio, which would be a comfortable number for Wall Street, he could make profit-boosting acquisitions in the range of $600 million.
BARGER THEORIZES THAT O'LEARY will use some of his hefty war chest to buy a wind-power-related manufacturer in Europe to increase overseas business, which now represents about 30% of net sales. But O'Leary acknowledges that the weak dollar won't go far in purchases abroad, and he indicated to us that he'd rather expand his business overseas using existing sales offices. He also believes that the corporation's wind-energy divisions can grow largely on their own.
Wind energy is the most exciting of the company's markets. For one thing, many big European manufacturers now see a hot market in the U.S. and are likely to move manufacturing facilities here and start favoring local suppliers.
The Bottom Line
Kaydon's shares, up smartly this year, could climb another 155 to 20% in the next 12 months, powered by high-margin products in growth markets. The dividend may rise, too.O'Leary indicated that he will be courting Gamesa, the Spanish wind-turbine giant, which recently opened plants in Pennsylvania. Its components now come from Ameron International, in California, and several smaller U.S. companies. Ameron (ticker: AMN) has seen its shares rise from a low of $64 in March to the high 90s.
Kaydon does face risks. Wind energy could face a backlash from people who think the turbines' towers, sometimes 60 feet tall, disrupt landscapes. And orders for medical scanners, another application for bearings, may be crimped by reduced Medicare payments -- a result of federal budget-cutting -- says Gail Prochaska of IMV market research. Still, with high-margin products and a pile of cash, Kaydon is well-positioned for growth.
With any luck, the wind will stay at its back.
AI
