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Will A. O. Smith be Able to Sustain Momentum Amid Headwinds?

Zacks Equity Research

A. O. Smith Corporation AOS has impressed investors with its recent earnings streak, having surpassed estimates thrice in the four trailing quarters. The company’s share price increase reflects its impressive performance, exhibiting investor optimism over the stock.

In the past three months, the Zacks Rank #3 (Hold) stock has gained 15.2%, outperforming the industry’s growth of 4.4%.

We believe that its notable traction across markets will drive growth in the upcoming quarters.

Factors to Consider

A. O. Smith’s leading position in water heating equipment and water treatment product markets bodes well for future growth. Notably, the company’s defensive replacement market, which accounts for approximately 85% of the North American water heater and boiler volumes, has been witnessing an uptrend. For 2019, it believes that the water heater volumes in the U.S. residential industry will shoot up 100,000-150,000 units. The volume growth will be largely driven by new construction activities and expansion of replacement demand, as well as continued growth in tankless units.

Also, the company dedicatedly follows a capital deployment strategy and continually rewards its shareholders via repurchases and dividend increases. Notably, in 2018, it bought back 4 million shares for $203 million. At the end of 2018, it had roughly 6 million shares remaining under repurchase authority. Notably, the five-year compounded annual growth rate of A.O. Smith's dividend is approximately 30%.

However, higher selling, general and administrative expenses remain a headwind. Notably, higher advertising costs related to brand building, coupled with developmental and engineering costs associated with new products are driving the company's operating expenses in China. Also, it expects to incur a loss of $2-$3 million in 2019 in India.

Although A. O. Smith’s expansion initiatives hold good for long-term growth, the high capital expenditure incurred will negatively impact its short-term earnings. Also, corporate expenses are likely to be $50 million in 2019, higher than $47 million in 2018, primarily on account of inflation. These actions are expected to put pressure on its profitability in the near term. In addition, for 2019, the company anticipates unfavorable movement in Chinese currency to have an adverse impact of about 3-6% on revenues.

Stocks to Consider

Some better-ranked stocks from Zacks Industrial Products sector are Axon Enterprise, Inc AAXN, Pioneer Power Solutions, Inc. PPSI and Dover Corporation DOV. While Axon Enterprise sports a Zacks Rank #1 (Strong Buy), Pioneer Power Solutions and Dover carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Axon Enterprise delivered average earnings surprise of 391.67% in the trailing four quarters.

Pioneer Power Solutions pulled off average positive earnings surprise of 208.48% in the trailing four quarters.

Dover delivered average earnings surprise of 6.59% in the trailing four quarters.

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