KEMET Corporation: Why a Trade Resolution Can Bump Stock Up 63%

KEMET Corporation Trade Resolution Could Push Stock Up 63%
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KEMET Stock: Upside Gap Points to Possible Breakout

I was searching for potential breakouts on stock charts and came across KEMET Corporation (NYSE:KEM), a century-old global supplier of electronic components such as capacitor technologies, electromagnetic compatibility solutions, electromechanical devices,  and supercapacitors.

The company’s products are found in a broad range of electronic devices in sectors including automotive, alternative energy, communications, computers, industrial,  medical, and military.

KEMET is clearly affected by the current global trade tensions since the company runs more than 20 manufacturing plants worldwide and sells to about 140 countries.

For patient investors, KEM stock is worth a look since the global trade situation will eventually be resolved, albeit the timing is unclear. For investors who are willing to endure some volatility, this stock could pay off.

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KEMET stock is currently trading below the midpoint of its 52-week range, down about five percent this year and down 17.4% over the past year.

A look at the below chart shows the sideways channel for KEM stock, with major support at $16.00 drifting back to October 2018 and the channel resistance at $21.50.

Chart courtesy of StockCharts.com

A bullish sign recently surfaced after KEMET stock gapped higher, which could signal an upcoming breakout attempt and an eventual move toward $22.75, $24.00, and $30.00—representing a potential move of about 60%.

Small Hiccup for KEM Stock, but I Feel Positive

KEMET Corporation’s revenues were inconsistent from fiscal 2015 (ending in March) to fiscal 2017, prior to acquisitions that drove revenue growth of almost 60% in fiscal 2018, followed by growth of about 15% in fiscal 2019.

Fiscal Year Revenue (Millions) Growth
2015 $823.2
2016 $735.6 -10.6%
2017 $757.8 3.0%
2018 $1,200 58.4%
2019 $1,380 15.2%

(Source: “Kemet Corp.MarketWatch, last accessed September 6, 2019.)

KEMET is expected to record a revenue decline of 3.9% to $1.3 billion in fiscal 2020, prior to staging a small 3.2% increase to $1.4 billion in fiscal 2021. (Source: “KEMET Corporation (KEM),” Yahoo! Finance, last accessed September 6, 2019.)

What you want to see is for KEMET to provide stronger organic revenue growth.

The company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) increased in five consecutive years, driven by acquisitions. A near doubling in EBITDA in fiscal 2018 was followed by impressive growth of almost 50% in fiscal 2019.

Fiscal Year EBITDA (Millions) Growth
2015 $75.94
2016 $79.9 5.2%
2017 $94.3 18.2%
2018 $179.8 90.5%
2019 $264.6 47.2%

(Source: MarketWatch, op. cit.)

KEMET turned its generally accepted accounting principles (GAAP) earnings per share (EPS) positive in fiscal 2017 and fiscal 2018, but recorded a decline in fiscal 2019 that drove some selling of its shares.

Fiscal Year GAAP Diluted EPS Growth
2015 -$0.44
2016 -$1.17 -169%
2017 $0.87 174.4%
2018 $4.33 398.1%
2019 $3.50 -19.3%

(Source: MarketWatch, op. cit.)

The company needs to work on its profitability, as its adjusted earnings are expected to slide to $2.83 per diluted share in fiscal 2020 (versus $3.54 per diluted share in fiscal 2019), but recover slightly to $2.94 per diluted share in fiscal 2021. (Source: Yahoo! Finance, op. cit)

KEMET managed to generate higher positive free cash flow (FCF) in four straight years from fiscal 2015 to 2018. Its FCF turned negative in fiscal 2019 for the first time in five years.

Fiscal Year Free Cash Flow  (Millions) Growth
2015
2016 $11.9 448.2%
2017 $46.1 257.1%
2018 $58.5 27%
2019 -13.6 -123.2%

(Source: MarketWatch, op. cit.)

Analyst Take

While KEMET Corporation has added risk given the current international trade situation, this should eventually sort its way out. The reality is that KEMET stock has declined to more attractive levels to account for the risk.

Consider that KEM stock is trading at 6.3 times its consensus EPS for fiscal 2021 and it has a cheap price/earnings to growth (PEG) ratio of 0.5. This low valuation should provide some downside support.

The key factor is that investors may have to wait out the trade wars.