Kennametal's Cash Flow Trap: Why the Negative Number Is a Setup, Not a Breakdown

Kennametal made its most profitable fiscal year ever and still ended the period with no free cash flow to show for it. Revenue jumped 20 percent to $2.36 billion. Adjusted EBITDA margins hit a record 26.9 percent. But free operating cash flow flipped from a positive $121 million to negative $79 million. The stock, which hit $44 earlier this year, is now trading around $29.

That cash flow reversal is what the market fixated on. But the reason behind it matters more than the number itself — and the reason points to a temporary pressure that should reverse, not a broken business.

The Tungsten Working Capital Build

Kennametal manufactures cutting tools and wear-resistant parts from tungsten carbide — the hard alloy that machine tools and mining equipment depend on. Tungsten is the raw material at the center of its entire operation.

During fiscal 2026, tungsten prices surged to historically high levels. Kennametal had to stockpile inventory and make advance payments to suppliers to secure its supply. Inventory ballooned from $538 million to $1.11 billion, consuming about $593 million in cash.

This is working capital absorption, not operating decline. The company's operating income actually more than tripled, from $99 million in fiscal 2025 to $473 million. The gap between earnings and cash flow was entirely the inventory build. Think of it this way: Kennametal paid cash for tungsten today that it will sell as tools over the next 12 to 18 months. That cash isn't destroyed — it's sitting on the shelf in a different form.

The share repurchase program was paused due to higher tungsten pricing. Debt increased from $1.22 billion to $1.55 billion. Combined liquidity (cash plus revolver availability) sits at roughly $926 million, with a new $500 million term loan facility added to cover the gap. The balance sheet is stretched but not strained — current ratio at 262 percent, debt-to-equity at 0.44, nearest note maturity in 2029.

The Operating Story Did Not Break

This is the part that separates tape pain from business pain. Underneath the working capital noise, Kennametal's operations improved dramatically in fiscal 2026:

• 19 percent organic sales growth, driven by pricing actions to offset unprecedented tungsten cost increases.
• Revenue grew across nearly every end market: energy up 101 percent, earthworks up 76 percent, aerospace and defense up 43 percent, general engineering up 28 percent, transportation up 7 percent.
• Record adjusted EPS of $4.57, up from $1.34 a year earlier.
• $27 million in restructuring savings already flowing through, with a commitment to reach $110 million in cumulative savings by fiscal 2027 year-end.

The market's concern is understandable. A company that turns a positive $121 million into a negative $79 million in cash flow looks like it's losing something fundamental. But this was a known, one-time inventory absorption event. The tungsten price spike has now plateaued at those elevated levels. Management said working capital requirements are expected to stabilize and begin stepping down in the second half of fiscal 2027.

The Forward Cash Flow Bridge

Management guided fiscal 2027 free operating cash flow at approximately 20 percent of adjusted net income. With adjusted EPS guided at $4.15 to $5.15 — midpoint of $4.65, essentially flat year-over-year on an operational basis — that works out to roughly $35 to $42 million in free cash flow for the year.

That is modest by the old standard. But it's a step function improvement from negative $79 million, and the normalization isn't done. The working capital build peaks in fiscal 2027's second quarter. Management expects free cash flow to turn positive in the third quarter as inventory valuations stabilize. Once the tungsten inventory overhang clears, cash conversion should snap back toward the levels that justified this company's valuation before the spike — and the operating margins are now structurally higher than they were then.

On a forward basis, at $29, Kennametal trades at roughly 6.3 times the midpoint of next year's guided adjusted EPS. The trailing P/E is 6.5 times. A 27-year dividend streak at a 2.7 percent yield. This is not a multiple that reflects a company about to print record margins and grow sales across every segment. It reflects a company the market still prices as though the cash flow problem is permanent.

The Headwinds Are Named, Not Hidden

The guidance midpoint of $4.65 for fiscal 2027 includes specific drag that management quantified directly:

• $0.23 per share from the Bolivian government ending a preferential exchange rate program.
• $0.25 per share from higher interest expense on the additional debt used to fund working capital.
• Higher tax rate, moving from roughly 23 percent toward 25 percent.

Stripping those non-operational headwinds out, the underlying earnings power is actually growing on the back of the fiscal 2026 momentum. The flat EPS midpoint is not a ceiling — it's the floor after accounting for known costs.

There are real operational risks, too. Global light vehicle production is expected to decline about 1 percent in fiscal 2027. U.S. coal markets are soft. The company is shifting resources away from transportation toward higher-margin opportunities like carbon fiber machining, which targets a $500 million market growing 9 percent annually through 2028. That transition has execution risk. And if tungsten prices spike again, the working capital problem repeats.

What Would Prove the Market Right

This setup breaks if the inventory overhang doesn't release. If Q2 and Q3 fiscal 2027 still show material working capital absorption, the cash flow normalization thesis needs to be rethought. If the broader industrial cycle turns down faster than expected — particularly in energy, earthworks, and aerospace, which are carrying the volume growth — the pricing power that drove margin expansion could fade. And if the restructuring savings program stumbles, the $110 million target becomes a ceiling rather than a floor.

Any of those outcomes would mean the operating story did break, not just the cash flow timing. The stock at $29 would then reflect a business with structural problems, and cheap would simply be cheap for a reason.

The Inflection

Kennametal is an example of what happens when a temporary cash flow event collides with an improving operating trajectory. The market saw negative cash flow and stepped away. The working capital build from tungsten pricing was real and it was large — roughly $570 million in additional inventory. But it's a timing event, not a permanent drain, and it's already peaking.

The operating side tells a different story: record margins, broad-based revenue growth, restructuring savings flowing through, and a forward multiple that still prices in fear of a cash flow problem that management has mapped out and quantified as resolving.

This is not about excitement. It is about a business that may soon look a lot harder to dismiss once the free cash flow shows up. The market is still pricing the old risk profile — a company that can't convert earnings to cash — while the operating setup is already at record profitability and the cash flow path has a specific inflection point in the second half of fiscal 2027.

The thesis is concrete enough to evaluate. The proof path is the Q2 and Q3 fiscal 2027 cash flow releases. If inventory stabilizes and free cash flow turns positive as management expects, the current 6.3 times forward multiple stops looking like a reflection of the business and starts looking like a reflection of patience. If it doesn't, the thesis breaks and the stock stays where it is.

I can be wrong again. But the setup is specific: buy a company trading at 6 times next year's earnings, with record margins and a known working capital overhang that peaks in two quarters, and wait for the cash to come home.