A.O. Smith (NYSE: AOS), a manufacturer of water heating equipment and electric motors, saw its revenues fall 8% in the last four quarters. Despite this, AOS stock has gained 27% – moving from $45.39 to $57.67 in the last 12 months. In fact, the company’s stock is currently 30% higher than its pre-Covid peak of $44.52. And, 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 also be noted that the water heater manufacturer’s EPS growth declined by 16% in 2019 even before the pandemic. All of these elements lean toward an organic revenue and EPS decline that could continue post-Covid, resulting in a possible downturn in the company’s stock price.
AOS stock has slightly underperformed the broader markets between fiscal 2018 and now. The retailer’s stock is around 6% lower than it was at the end of fiscal 2017, compared to a 37% 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.
Although AOS stock declined 30% from around $61 in fiscal 2017 to close to $43 in fiscal 2018 – it partially rebounded 12% to around $48 in fiscal 2019. The company saw flat revenues and a 30% growth in earnings per share between 2017 and 2019. This was driven by a 250 bps net margins expansion from 9.9% to 12.4% and around a 4% decline in shares outstanding during this period.
Finally, A.O.Smith’s P/E ratio declined from about 36x at the end of FY 2017 to 21x at the end of FY 2019. While the company’s P/E is now around 26x, it could decline going forward due to weaker demand in commercial water heater volumes as compared to resilient demand in residential water heater volumes.
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 company saw its end-user demand in China decline persistently for several quarters due to its slowing economy during the 2018-2019 period. In addition, unfavorable currency headwinds and a product mix that consisted of a more lower-margin priced model, led to weaker sales in China.
How Is Coronavirus Impacting AOS Stock?
AOS revenues have declined 8% to over $2 billion so far, largely due to a 26% decline in the RoW segment (comprising of China, India, Europe) and flat sales in the North American market. The gross profit margin during this period was 150 bps lower due to lower sales volumes. In addition, adjusted EPS also declined by 14% in this period.
Going forward, the company expects consolidated sales to decline by approximately 6-7% in 2020 compared to 2019 due to declines in sales in China in the first-half of 2020, as well as lower commercial water heater volumes and boiler sales in the U.S. which will more than offset an expected 22 – 24% sales growth in North America water treatment products and expected 4% increase in U.S. residential water heater industry volumes.
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