Kaydon (NYSE: KDN) Set to Quadruple Wind Energy Sales Over 3 Years

Let’s take a look at a small-cap play that sells precision-engineered products into the demanding market for energy resource exploitation, where — it is not too strong to say — design or mechanical failure is simply not an option. The company also sells components to the wind energy industry. The company’s name is Kaydon Corp. (NYSE: KDN).

To set the stage, let’s think about how a drilling rig, whether onshore or offshore, is similar to an electricity-generating windmill farm. Both kinds of structures tend to reside in environmentally harsh and inaccessible locales. Therefore, both kinds of structures must possess the durability to resist the elements — from saltwater to blazing sun to extreme temperature to hurricane-force winds to rogue waves. Drilling rigs and windmills must both support rotating machinery for many hours per day, amidst many different kinds of conditions. And, if the critical machinery does not rotate, then both drilling rigs and windmills are worse than junk. They are junk that is costing the owner or operator a lot of money.

Day rates for the big, offshore drilling rigs can be as high as $500,000… or even more for the real behemoths. Do the math on that. Figure that the rig lessee is paying more than $20,000 per hour, whether the rig is running or not. So if you are an operator that has a very costly drilling rig under agreement, downtime is immensely expensive. You will simply not accept downtime that is caused by mechanical failure, no matter what the explanation. Your instruction to the rig manager is, “Don’t let anything break.” Another way of saying it is, “Use the very best equipment. Pay whatever it costs.”

And now let’s consider a windmill, perched, often as not, atop a 250-foot tower that is constructed on some remote mountaintop or in some distant prairie, far from the nearest machine shop. Its massive blades may be spinning thousands of revolutions per hour, 18 or 20 or more hours per day, every day of every week, every week of every year, generating megawatts of electricity that are flowing into the power grid. But consider the rigors of that environment. The wind may gust from a very low speed to powerful blasts within a matter of seconds, and then the wind may die down, and soon thereafter repeat the process all over again. So the mechanical workings of the windmill have to absorb and transmit immense stresses, with the rotating machinery gearing up and gearing down, again and again, over the very long haul. But, the windmill is almost never attended by a human maintenance worker.

So the windmill system must be designed and built to tolerate the rigors of a high-wind environment. And the customers for that electricity, the electric utilities, are under legal mandate from numerous regulatory bodies to keep their electric grid powered up. So again, the instruction to the windmill operator is, “We need consistent levels of power from your windmill farm, so don’t let anything break.” And not uncommonly, someone is also saying, “Use the very best equipment. Pay whatever it costs.”

Now, let me introduce you to a company that makes that “very best equipment” for these extreme kinds of applications. This company manufactures products for which people are more than willing to pay “whatever it costs.” And that company is the aforementioned Kaydon Corp. of Ann Arbor, Michigan.

Kaydon Corp., incorporated in 1983, is a world leader in the design and manufacture of custom-engineered, critical-performance products, to include bearing systems and components, filters and filter housings, as well as custom rings, shaft seals, linear deceleration products, specialty retaining rings, specialty balls, fuel cleansing systems, gas-phase air filtration systems and replacement media, industrial presses and metal alloy products. And this product line is far more than what you might buy down at your local auto parts dealer. These products are used by high-end, mostly high-tech, customers in a wide range of critical machine-positioning applications, instrumentation systems, material handling devices, aerospace and defense systems, security applications, high-tolerance construction efforts, electronic and even medical applications.

As for the wind energy industry, Kaydon Corp. generates less than 10% of its 2006 sales from this business segment. But the company’s sales to the wind energy industry are growing very rapidly. In fact, Kaydon expects to quadruple its sale to the wind energy industry over the next three years.

At the current quote of $49 a share, Kaydon Corp.’s stock is selling for less than 20 times estimated 2008 earnings. There are about 28.2 million shares outstanding, giving the company a market capitalization of about $1.38 billion. Last February, when I recommended the stock to the readers of my investment letter, the American edition of Outstanding Investments, Kaydon Corp. was trading around $45. So it has had a nice rise over the past few months. But then again, the stock is rising for a lot of good reasons, and those reasons appear to be continuing into the future… especially in the wind energy industry.

In remarks earlier this year, Kaydon’s President and Chief Executive Officer Brian Campbell referred to “the strength of Kaydon’s proprietary product positions and disciplined strategic direction. We believe our strong order intake during the year, combined with increased current incoming order rates and customer product availability inquiries, lay the foundation for increased operating performance in the current year.”

One of Kaydon’s strengths going forward is, as mentioned above, its sales into the wind turbine market, particularly the critical bearings components of windmills. This is because the windmill sector of the market is growing at near breakneck speed, and the company is expanding its capacity and sales efforts in this line of business. In 2006, investment in windmill systems in the U.S. was second only to investment in new coal-fired power plants for the production of electricity. So Kaydon is positioning itself into the sweet spot of a fast-growing market.

The key problem in developing windmill systems at the present time is the availability of windmill turbines, and this puts the investment spotlight squarely on one of Kaydon’s most profitable new business lines going forward. “We would love to build more wind farms,” says John Hofmeister, president of Shell Oil Company. “We have the real estate and the permits. We certainly have the funds to construct these facilities. But our biggest problem is just the availability of windmills. We are experiencing a two- to three-year delay in delivery of windmill systems.”

Two- to three-year delays? And this from a large, well-capitalized company like Shell that can pretty much buy what it wants? Sounds to me like a growth story for a precision-maker of a critical product — the kind about which people say things like, “Use the very best equipment. Pay whatever it costs.”

Byron W. King
for Markets and Money

Byron King
Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments.

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Errr… why should I care about this ? They are listed on NYSE. I would have to buy USD to buy this stock. Not a good idea.

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