A. O. Smith Corporation AOS is poised to gain from improving supply chains, which are driving shipments in North America and internationally. The company’s handsome rewards to shareholders add to its appeal.
Based in Milwaukee, WI, A. O. Smith is a leading manufacturer of commercial and residential water heating equipment and water treatment products. The company specializes in offering innovative, and energy-efficient solutions and products, which are developed and sold globally.
Let’s discuss the factors that should influence investors to retain the stock for the time being.
Growth Catalysts of AOS
Business Strength: AOS’ North America segment’s (revenues up 9% year over year in the second quarter) results benefited from increasing demand for residential and commercial water heaters and commercial boilers. Also, the introduction of tankless products bodes well for the segment. A. O. Smith expects sales from both the North America boiler and water treatment businesses to grow approximately 8-10% this year. Strength in the Rest of the World segment (revenues flat year over year in the second quarter) is driven by higher volumes of combi boilers and kitchen appliance products in China. Sales from India were particularly strong, jumping 16% year over year in the second quarter 2024quarter.
Expansion Efforts: The company solidifies its product portfolio and leverages business opportunities by adding assets. For instance, in July 2024, it signed a definitive deal to acquire the Pureit business from Unilever. The inclusion of Pureit’s expertise in water treatment solutions, coupled with its strong brand recognition, will enable A. O. Smith to expand its customer offerings and boost its position in the water treatment industry in India.
In March 2024, the company acquired the privately held Impact Water Products, which expanded its water treatment footprint in North America. The acquired company has been included in the North America segment. The June 2022 acquisition of Atlantic Filter boosted the company’s position in the water treatment industry and strengthened its customer base in Florida and the adjacent regions. The acquisition of Canada-based Giant Factories in October 2021 expanded its commercial and water heater offerings. The company spent $21.3 million on acquisitions in the first six months of 2024.
Rewards to Shareholders: AOS is committed to rewarding its shareholders handsomely through dividends and share buybacks. In the first six months of 2024, it paid dividends worth $94.2 million, up 4% year over year. In October 2023, A. O. Smith increased its dividend by 7% to 32 cents per share (annually: $1.28). The company has increased its dividend consecutively for more than 30 years. Last quarter, it had also repurchased 1.8 million shares for $153.2 million.
With 3.7 million shares left to be repurchased under the existing authorization, the company’s board boosted the buyback program by another 2 million shares. For 2024, it expects to repurchase shares worth approximately $300 million.
In the past year, this Zacks Rank #3 (Hold) company’s shares have gained 16.9% compared with the industry’s 10.1% growth.
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Headwinds for AOS
Weakness in the Chinese Real Estate Market: Given the nature of its products, the company’s fortunes are closely tied to the construction market. Therefore, the ongoing challenges in the Chinese real estate market are a concern for A. O. Smith. Decreasing demand for residential water treatment products in the region is challenging. As a result, the company lowered its 2024 third-party sales growth outlook for China. It expects the metric to be flat to up 3% in local currency.
Rising Expenses: Escalating expenses are a pressure on A. O. Smith’s bottom line. In 2023, the company’s selling, general and administrative (SG&A) expenses increased 8.4% year over year. The metric, as a percentage of sales, increased 80 basis points. The trend appears to be continuing this year, with both costs of sales and SG&A expenses remaining on an uptrend.
The company’s cost of sales was $628.3 million in the second quarter, up 9.1% year over year due to higher material costs. SG&A expenses were up 4.5% year over year. The increase was attributable to higher employee costs from increased wages and management incentives. The company’s raw material costs primarily depend on steel prices, which are subject to fluctuations over time. It has been witnessing volatility in steel costs over the past several quarters. Any increase in cost that does not generate sales growth would directly impact margins and profitability.
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