Divesting AT&M Business And Medical Sector Focus Fuels Future Growth Prospects

Key Takeaways

• Divestiture of AT&M business and focus on core EMS operations may enhance revenue, net margins, and future growth by reallocating resources towards higher growth potential areas.
  
• Strengthened balance sheet and financial flexibility from AT&M sale and improved working capital management to support future acquisitions and growth initiatives, particularly in the medical sector.
  
• Narrowing focus on EMS operations and reliance on key sectors exposes Kimball Electronics to innovation limits, execution risks, and economic uncertainties impacting growth and stability.

Catalysts

Engages in the provision of electronics manufacturing, engineering, and supply chain support services to customers in the automotive, medical, and industrial end markets.

• The divestiture of the Automation, Test & Measurement (AT&M) business is expected to sharpen Kimball Electronics' strategic focus on core EMS operations, suggesting a potential positive impact on future growth and profitability as resources are reallocated towards areas with higher growth potential, likely enhancing revenue and net margins.
  
• Strengthened balance sheet from the sale of AT&M and improved working capital management, providing increased liquidity and financial flexibility, which could support future acquisitions, especially in the medical space. This financial health is key to funding growth initiatives or pursuing strategic acquisitions that can enhance revenue streams and margins.
  
• Focus on expanding the medical vertical, highlighted by significant new wins and an ongoing search for acquisition targets within this sector. The emphasis on higher-level assemblies and finished medical device opportunities signals a potential for higher-margin business expansion, positively affecting net margins and earnings through diversification and entry into new geographies or capabilities.
  
• Initiatives to maintain competitiveness and stabilize operating margins in the face of challenging EMS industry conditions, such as adjusting cost structure and purposefully driving inventory levels lower to generate positive free cash flow. These efforts aim to support financial stability and improve net margins despite external pressures.
  
• Commitment to capital return to shareholders through share repurchase programs, indicating confidence in the company's financial health and future prospects. This approach can contribute to earnings per share (EPS) growth, providing a favorable outlook for shareholder returns and potentially making the stock more attractive to investors.

Assumptions

• Analysts are assuming Kimball Electronics's revenue will decrease by -4.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.2% today to 3.2% in 3 years time.
• Analysts expect earnings to reach $47.9 million (and earnings per share of $1.83) by about October 2027, up from $20.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.8x on those 2027 earnings, down from 21.6x today. This future PE is lower than the current PE for the US Electronic industry at 23.7x.
• Analysts expect the number of shares outstanding to decline by 0.24% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.43%, as per the Simply Wall St company report.

Risks

• The divestiture of the Automation, Test & Measurement business and the focus exclusively on core EMS operations might limit diversification and innovation potential, impacting long-term growth and profitability.
  
• The setback with the electronic braking system program highlights execution risks in new projects, potentially affecting revenue and credibility in the automotive sector.
  
• Dependence on key customers, particularly in the medical sector, is risky, as shown by the lost revenue due to an FDA recall, affecting net margins and overall financial health.
  
• Expected decline in net sales for fiscal year 2025, with an 8% to 14% decrease compared to fiscal 2024, signals potential challenges in achieving growth, impacting investor confidence and share prices.
  
• Ongoing global economic uncertainties and changes in consumer demand across all served verticals, including automotive and industrial, might lead to reduced orders and increased inventory, negatively affecting cash flow and margins.

Valuation

• The analysts have a consensus price target of $23.25 for Kimball Electronics based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $29.0, and the most bearish reporting a price target of just $19.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.5 billion, earnings will come to $47.9 million, and it would be trading on a PE ratio of 14.8x, assuming you use a discount rate of 8.4%.
• Given the current share price of $17.89, the analyst's price target of $23.25 is 23.1% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.