Morgan Stanley cuts Kennametal stock rating on tungsten price impact

Morgan Stanley downgraded Kennametal (KMT) to Underweight and cut its price target to $27.00 from $31.00, despite the stock trading at $33.13 (P/E 7.73). The analyst pointed to tungsten prices up >500% since Aug 2025, which boosted margins temporarily: FY4Q 2026 EBITDA margins rose to 46.3% vs a 17.5% historical average, and FY2027 EPS guidance of $4.15–$5.15 includes $3.50 of raw-material timing benefit (implying normalized EPS of ~$1.15 at the midpoint). Morgan Stanley expects the unwind of this benefit to outweigh any cyclical volume recovery over the next 12 months, contributing to a cautious outlook even after the company’s FY4Q results beat on adjusted EPS ($2.96 vs $2.32) and revenue ($736.6M vs estimates).

Analysis

KMT reads like a temporary earnings-quality story being mistaken for a structural re-rating. The market is capitalizing peak margins created by raw-material timing, but that benefit is inherently self-reversing: as inventory rolls and purchase-cost inflation fully flows through, reported EBITDA and cash conversion can fall together even if unit demand is merely stable. On normalized earnings, the stock is far more expensive than the headline multiple suggests, which is why the downgrade matters more than the low P/E implies.

The second-order effect is on customers, not just KMT. Tooling and wear-part inflation is usually a small line item for aerospace, auto, and general industrial OEMs, so near-term demand destruction should be limited; however, that makes price pass-through easier and delays the point at which management gets punished for margin compression. The real competitive risk is share loss to suppliers with better raw-material hedging, longer-duration contracts, or less tungsten intensity; if KMT is forced to reprice aggressively while peers lag less, its volume recovery could disappoint even before the margin unwind hits.

Catalyst path is 1-3 months: the next print and any commentary on inventory turns, contract resets, or normalized gross margin will matter more than top-line growth. Over 6-18 months, this should look less like a cyclical industrial recovery and more like a mean-reversion trade in reported EPS. What would falsify the short thesis is either a meaningful pullback in tungsten prices or evidence that the elevated timing benefit is durable enough to keep normalized margins above low-teens EBITDA for another year; absent that, the current price looks vulnerable to multiple compression and estimate cuts.

Key Decisions for Investors

• Short KMT common or buy 3-6 month put spreads on any post-downgrade bounce; thesis is a re-rating from peak-margin optics back toward normalized earnings, with downside driven by guidance reset and cash-flow disappointment.
• Use a target band of roughly $27 as the first de-risk level; if KMT trades and holds above that level after the next update, the market is signaling belief in a longer tungsten windfall and the short should be reassessed.
• Pair short KMT against a higher-quality industrials basket proxy such as XLI if you want to isolate name-specific earnings-quality risk rather than take broad industrial beta.
• Set an alert on tungsten spot/pricing and any supplier contract commentary; if tungsten retraces materially or management quantifies a lower normalized margin than implied, cover shorts quickly because the thesis is timing-driven, not purely fundamental.