A. O. Smith: A Decent Boiler Play
Contributor since 2011 / 25995 Followers
Summary:
- A. O. Smith Corporation is a player in various water products, predominantly boilers.
- The company has shown solid long-term value creation, growing sales and margins significantly over the past decade.
- Despite a strong balance sheet, a recent bolt-on deal, and solid outlook, the current valuation at 22 times earnings looks full.
Monty Rakusen
Shares of A. O. Smith Corporation (NYSE:AOS) deserve an update after a bolt-on acquisition of Pureit from Unilever (UL) as of late, and growing exposure to emerging markets, in this case India. The deal looks quite reasonable, as A. O. Smith operates with a strong net cash position.
The bolt-on deal looks nice but is not a game changer, and after a solid return over the past decade, shares are now left trading at a small premium to the overall market.
It is this share price move and small premium which makes me cautious on the shares even as I am constructive on the business, making me watch the events unfold from the sidelines here.
A Water Business
A. O. Smith is a near $4 billion water business, which has been around for some 150 years. The company provides water heaters, boilers, and water treatment solutions. Applications include tanks, heat pumps, softeners, and filtration products for residential and commercial markets, with some three quarters of sales generated in North America.
The company operates a workforce of 12,000 across 27 facilities, serving clients in some 80 countries. Operating with a range of brands, including the namesake brand, the company is the largest manufacturer and marketer of water heaters and boilers. With a huge recurring revenue component and focus on decarbonization, the company is an interesting play with dominant positions in emerging markets like China and India as well.
On top of these boilers, the company has started to grow a water treatment business as well since the 2010s, an intriguing business, which by now has grown to half a billion in sales.
A Decent Play
Truth be told is that A. O. Smith has delivered on solid long-term value creation. Over the past decade, the company has grown sales by about two-thirds, from $2.3 billion to $3.8 billion.
Over this period of time, the company has grown operating margins from the low double-digits to about 20%, all while the company bought back about one in every six shares outstanding. The combination of all this has created a massive uplift in earnings per share.
These achievements are very noteworthy and have been picked up by the market as well. Just a $20 stock in 2014, shares have gradually risen to the $80s in 2021, followed by a pullback to the $50 mark in 2022. Ever since, shares have made gradual inroads again, now trading at all-time highs around $90 per share.
Picking Up The Valuation Discussion
In January, A. O. Smith posted its 2023 results, a year in which revenues were up 3% to $3.85 billion, driven by higher water heater volumes. The company kept on growing margins, with adjusted earnings reported at $575 million, with earnings per share up 21% to $3.81 per share.
The company pays out a relative small portion of these earnings, although that quarterly dividends of $0.32 per share result in a dividend yield of just around 1.4%. However, this was the 84th consecutive year of dividend payments made to investors!
The balance sheet is strong, as the company operates with a net cash position of around a quarter of a billion, equal to less than $2 per share based on a share count of 150 million shares. Adjusted for net cash, the unleveraged assets trade around 23 times earnings. While not being leveraged, the long-term growth trajectory is quite solid, and the same goes for the track record.
The company outlined a solid outlook for 2024, but nothing special, with sales seen up between 3 and 5%, with earnings seen between $3.90 and $4.15 per share.
In April, the company posted reasonable, but non-impressive first quarter results. Revenues rose by a percent, with adjusted earnings per share up 6% to $1.00 per share. Net cash holdings came down to $163 million, in part due to buybacks, which reduced the share count to about 148 million shares.
All this values the enterprise at just over $13 billion here, valuing the business at about 3.2 times sales and around 22 times earnings.
A Bolt-On Deal
In July, the company announced a bolt-on deal. As mentioned, the company announced the acquisition of Pureit from Unilever. Pureit offers residential water purification solutions, with A. O. Smith paying a 2 times sales multiple based on a revenue contribution of $60 million, and $120 million acquisition price.
With a purchase price equal to a percent of the valuation and the sales contribution pegged about 1.5% to overall sales, this is really a bolt-on deal. The deal will deplete net cash balances substantially, but, of course, the balance sheet remains strong.
What Now?
Given the discussions beforehand, I think that A. O. Smith is a nice and decent company, having seen solid advancements over the past decade. This is recognized by the share price as well — in fact, more than recognized, as a current 22 times earnings multiple is full.
The share price has made giant advancements, having risen about ten dollars recently. This move alone has pushed up valuations from 19 to 20 times to about 22 times earnings here.
The A. O. Smith Corporation multiple feels a bit too rich to see real appeal, especially after shares have been trading at more modest valuations recently. This makes me cautious about chasing the shares here near fresh all-time-highs, especially with softness in other pockets of the market offering opportunities there as well.
Given all this, I am constructive on A. O. Smith as I like the business and long-term track record, yet find the current performance not impressive enough and the valuations a bit too rich to see great appeal here.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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