Is A.O. Smith Stock A Buy?

A.O. Smith (NYSE: AOS), a manufacturer of water heating equipment and electric motors, saw its revenues fall 3% year-over-year (y-o-y) for the last four quarters. Despite this, AOS stock has gained 35% – moving from about $44 to $59 in the last 12 months. Investors seem to be pleased with its better-than-expected full-year results where it earned $2.12 per share (-5% y-o-y) on revenue of about $2.9 billion. Consequently, the company’s stock climbed up and is 33% higher than its pre-Covid peak of around $45 in Feb 2020. That said, we believe that this mismatch between revenue growth and stock movement over recent quarters points to a likely reduction in A.O. Smith stock in the near future.

It should be noted that A. O. Smith’s net income has not shown growth over the past three years. In fact, the water heater manufacturer’s annual net income declined by 17% in 2019 – even before the pandemic. A.O. Smith has been focused on two core markets: North America and the Rest of the World (RoW). While it derives around two-thirds of its revenues from replacements in the slow-growing North American market, China (more than 94% of this RoW segment) offers a vast opportunity in terms of increased housing development. However, the China market saw its end-user demand decline persistently before the pandemic. Sales in China declined due to trade tensions, unfavorable currency headwinds, and a product mix that consisted of a more lower-margin-priced model. All these elements point to the fact that the industrial company’s trajectory could get back to its slower pace once the Covid threat abates.

AOS stock has underperformed the broader markets between fiscal 2018 and now. The retailer’s stock is around 38% higher than it was at the end of fiscal 2018, compared to a 58% growth in the S&P. Our dashboard, Buy or Sell A.O. Smith Stock?, provides the key numbers behind our thinking, and we explain more below.

AOS stock grew 28% from around $43 in fiscal 2018 to close to $55 in fiscal 2020. The company saw a 9% decline in revenues and a 18% fall in earnings per share between 2018 and 2020. This was driven by a 200 bps net margins contraction from 13.9% to 11.9% and around a 5% decline in shares outstanding during this period.

Between 2018-2020, A.O. Smith’s stock grew largely due to the market assigning it a higher P/E multiple. The company’s P/E ratio increased from about 16x at the end of FY 2018 to 26x at the end of FY 2020. While the company’s P/E is now around 28x, it has a downside risk when compared to its P/E multiple of past years. The current P/E multiple looks likely unsustainable given the past financial performance of the company.

How Is Coronavirus Impacting AOS Stock?

For the full-year 2020, AOS revenues increased 2% y-o-y in the North American division and declined 14% y-o-y in RoW, largely due to weak demand in the first half of 2020. However, the company saw improved trends by Q4 as the company’s revenue grew a strong 7% y-o-y in the North America division and 19% in the RoW segment. Going forward, the company posted an earnings guidance of 13% improvement in 2021. But, the company also hedged the number as it assumes that the rest of 2021 would be similar to its recent business performance. We expect AOS to continue to see weak demand in commercial water heater volumes as compared to resilient demand in residential water heater volumes in the near term.

While AOS stock may have moved, 2020 has created many pricing discontinuities that can offer attractive trading opportunities. For example, you’ll be surprised how the stock valuation for TJX vs Abiomed shows a disconnect with their relative operational growth. You can find many such discontinuous pairs here.

See all Trefis Price Estimates and Download Trefis Data here

What’s behind Trefis? See How It’s Powering New Collaboration and What-Ifs For CFOs and Finance Teams | Product, R&D, and Marketing Teams