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Here's Why You Should Avoid Betting on A. O. Smith (AOS) Now

Zacks Equity Research

We have issued an updated research report on A. O. Smith Corporation AOS on Dec 26.

Currently, this water heating and water treatment products manufacturer has a Zacks Rank #4 (Sell) and a market capitalization of approximately $7.3 billion.

Let’s delve deeper and discuss what led to the company’s poor investment appeal.

Share Price Performances, Poor Valuation & Earnings Estimate Revision: Market sentiments are currently against A. O. Smith. In the past six months, the stock has decreased roughly 26.3% compared with the industry’s 17.5% decline.



Also, over the same timeframe, A. O. Smith appears overvalued compared with the industry. On a Price/Earnings (P/E) basis, the stock is currently trading at 17.5x higher compared with the industry’s 14.9x. Further, the stock’s current valuation multiple is approaching the industry’s median level of 18.6x over the past six months.

In the past 60 days, A. O. Smith’s earnings estimates for 2018 have been lowered by seven brokerage firms, while that for 2019 were lowered by nine firms. Currently, the Zacks Consensus Estimate is pegged at $2.58 for 2018 and $2.82 for 2019, reflecting a decline of 1.1% and 3.1% from the respective 60-day-ago tallies.

A. O. Smith Corporation Price and Consensus

A. O. Smith Corporation Price and Consensus | A. O. Smith Corporation Quote

Surging Costs: Over time, the company has been dealing with adverse impacts of the rising cost of products sold and operating expenses. In the first nine months of 2018, its cost of products sold increased 6.7% year over year and operating expenses expanded 5.5%.

In this context, it is worth mentioning that higher prices of raw materials, especially steel, primarily contributed toward an increase in cost of products sold. Rising steel prices as well as increasing freights costs and other inflationary pressures are added concerns. However, A. O. Smith’s pricing actions will bring in some relief.

Meanwhile, investments in innovation, advancement of the existing product line and improvement of its e-commerce business as well as sales expansion in China are escalating the company’s operating expenses. For 2018, A. O. Smith predicts corporate and other expenses to be roughly $48 million versus $47 million recorded in 2017.

Forex Woes: Geographical diversification is reflective of A. O. Smith’s flourishing business. Markedly, the company derives a significant portfolio of its revenues from business operations in China, India and Europe. However, this diversity has exposed it to headwinds arising from geopolitical issues and unfavorable movements in foreign currencies. In the third quarter of 2018, forex woes negatively impacted sales of the Rest of World segment by roughly $6 million.

For the fourth quarter of 2018, the company predicts that unfavorable movement in Chinese currency might hurt sales and earnings by $12 million and $2 million, respectively.

A. O. Smith’s Bearish Projections: For 2018, the company has lowered its adjusted earnings projection from $2.59-$2.63 to $2.57-$2.60 per share. Also, sales are now anticipated to be up 7% compared with 9.5-10% anticipated earlier.

On a year-over-year basis, volumes for commercial usage in the U.S. water heater industry are expected to decline roughly 5%. The same for residential purposes are expected to be 250,000-300,000 units in 2018, down from 350,000-400,000 units guided previously. Furthermore, economic turmoil and trade conflicts with foreign nations have disrupted housing market in China. This, in turn, might prove detrimental to sales over there.

Stocks to Consider

Some better-ranked stocks in the Zacks Industrial Products sector include DXP Enterprises, Inc. DXPE, EnPro Industries, Inc. NPO and Enersys ENS. While DXP Enterprises and EnPro Industries sport a Zacks Rank #1 (Strong Buy), Enersys carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

For 2018, earnings estimates for all these three stocks were revised upward over the past 60 days. Further, positive earnings surprise for the last quarter was 17.95% for DXP Enterprises, 23.64% for EnPro Industries and 0.86% for Enersys.

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