A.O. Smith Is A Growth Stock At A Fair Price – A. O. Smith Corporation (NYSE:AOS)

A. O. Smith Corporation (NYSE:AOS) manufactures water heaters, boilers and water treatment products. The company has approximately 16,300 men and women at operations in the United States, Canada, Mexico, China, India, the United Kingdom, the Netherlands, and Turkey, which has the global reach to serve customers worldwide. The company has a 145-year history.

North America accounts for almost 64% of the total global revenue. The strong replacement sales of approximately 85% of total business show the sustainability of the business. The innovation, training and 24/7 national account customer service drive market leadership. Sales grew at a 10% CAGR over the past decade, EBITDA grew at 19% CAGR and EPS grew at 25% CAGR during this period. You can find its autumn 2019 analyst presentation here.

Historical dividend, yield and price movements:

The following table shows the market price movements, the dividend rates, the dividend growth rates and related derived data over the past decade.

Year

Open High Low Close Quarterly Dividend Rate Dividend Growth Over Previous Year Dividend Yield Low Dividend Yield High
2019 42.70 56.66 40.38 47.64 0.24000 33.33% 1.69% 2.38%
2018 61.28 68.39 40.34 42.70 0.18000 28.57% 1.05% 1.78%
2017 47.35 63.70 46.44 61.28 0.14000 16.67% 0.88% 1.21%
2016 38.31 51.49 30.15 47.35 0.12000 26.32% 0.93% 1.59%
2015 28.21 40.58 25.05 38.31 0.09500 26.67% 0.94% 1.52%
2014 26.97 28.58 22.07 28.21 0.07500 25.00% 1.05% 1.36%
2013 15.77 27.59 15.50 26.97 0.06000 20.00% 0.87% 1.55%
2012 10.03 15.99 10.03 15.77 0.05000 25.00% 1.25% 1.99%
2011 9.60 11.21 7.45 10.03 0.04000 1.43% 2.15%

Please note, the minimum and maximum dividend yields shown above are not perfect, since I used the revised dividend rate x 4 divided by the high/lows of the market prices to arrive at the possible maximum or minimum dividend yields in each of those years. It serves my purpose for a quick evaluation.

Why did the price performance turn bad in the last two years?

Besides the growing business in North America, AOS had rapid growth in China until 2018. Economy slowed in China in the last two years. AOS addressed these issues with a 20% headcount reduction, closure of 700 net retail stores, reduced SG&A and took initiative to reduce channel inventory. The 3rd quarter revenue of 2019 saw a 6% growth in North American revenue while the rest of the world saw a decline in revenue of about 20%. This saw an overall reduction in revenue of 3%. The year 2019 EPS guidance is given below:

AOS is now traded at around $45/-, a price range seen in the year 2016. The current dividend of 0.24 per quarter gives a dividend yield of 2.10% (the dividend is exactly double that of the dividend paid in the year 2016). The net cash flow from operations in 2019 is expected to be around that of year 2018. The Debt to Capital ratio is very low at 16%. The current dividend payout is 40% of the EPS. The current EPS yield is 5.28% on the market price. AOS is continuing to buy shares in the market.

My views

What I see here for my investment idea is that the sell-off happened on news. The reality should not bring more price crash, unless a new trend emerges. The market price consolidation has happened for quite an year with around $40 as the base. The emerging megatrends in other markets hold the trigger for future growth. The US trade agreement with China should bring back some moderate growth in China. The megatrend in India is another growth driver waiting to evolve. India’s population is large. The major component of North American sales is growing and sustainable. I view AOS as a growth pick at a fair value for my long-term portfolio. AOS has scheduled to report fiscal quarter Dec-2019 financial results on January 28, 2020. If the quarterly results give any negative surprises or if the markets turn choppy, AOS could retest the $40 or $42 range. The market in such a case could give a better discounted value than now. It is hard to find a growth stock with an EPS yield greater than 5%, i.e., a P/E multiple of less than 20 or a comparable low debt and low dividend payout. I went long in AOS with a small initial position at $45.21 today, ahead of the results. If the prices trend lower, I might add more at appropriate time.

Consumers in a country that’s famous for the thick clouds of smog that regularly blankets its major cities caused headwinds a year back. Can the coronavirus outbreak in the Wuhan region of China create more headwind for Nanjing, China-based factory of AOS? This is more of a short-term view. Can the maker of water heaters and purifiers which made a bet several years back on the Chinese air-purification and water-treatment market shoot AOS into growth orbits again? Can the megatrend in India, which is similar to the megatrend in China, continue to grow investments in AOS and maintain its growth trajectory for another decade? I think ‘yes’ and am bullish on AOS for the long term.

Please use your own diligence to make your buy or sell decision.

Disclosure: I am/we are long AOS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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