AOS A. O. Smith Corporation

Sector financial performance:

This company, which is primarily a manufacturer and marketer of residential and commercial water heater including water heater, boiler, and water treatment products, has been grouped into household appliance sector in household equipment industry.

It seems that, since 2015, there has been a strong growth in demand from China market for water heater and water treatment products that companies in this sector (present an average 8% annual growth) have been able to benefit from. It has been flat in terms of volume in North America market as a result of natural replacement rate of household water heater products. However, it seems the demand has grown faster since 2017 as indicated by the increasing sales volume in North America, which push growth rate of companies’ sales higher to 12% since 2017.

As a result of lower products costs (before 2017) and raised price, the typical companies’ gross margin has gone up to about 41 from 36% of 2014 during the same period and the typical operating margin is at around18% with a flat SG&A as percentage of sales of about 24% in 2018. Rising steel costs may cause companies to raise product price and improve margin to capitalized increase in sales in the past year.

Largely increased sales in China market and improved margin in North America market brought significant increase in cash flow for companies in this sector, which presents a  typical growth rate at around 15-35% in the past three years,

The typical average enterprise price/EBI ratio is: 28(interest/EBI ratio of 3%) and stock price/sales ratio is about 3.2.

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Company performance:

It seems that the demand for products of this company in the past several years has been growing fast driven by growth in China’s demand for water heater and water treatment products, which presents nearly 20% growth in the past two years. Demand for water heater from North America has been stable and stared to grow faster as a result of replacement of existing users and new housing demand. Demand for water treatment products has grown faster than others.

The first six months of 2018 compared with 2017

Sales (including currency) increased 7% (10% for 2Q) primarily due to increase in sales volume in China and North America.

The 2017 compared with 2016

Sales (including currency) increased 11.6% primarily due to increase of 18% in China (excluding currency) and increase in North America.

2016 compared with 2015

Sales (excluding currency) increased 8% primarily due to increase of 19% in China (excluding currency) and increase of 35% in water treatment products.

Fiscal 2015 compared with 2014

Sales (including currency) increased about 8% primarily due to increase in price in North America market and increase in China (mainly water heater and treatment products).

Its gross margin has increased from around 36% in 2014 up to about 41% of 2018 due to rising price in North America. The SG&A as percentage of sales has been flat at around 24% and its operating margin thus went up to about 18% in 2018.

Stock price

This stock currently has an enterprise price/EBI ratio of 28 ($59). We think that its stock is being relatively slightly undervalued considering potential increase in margin as a result of raising price.