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Can A. O. Smith (AOS) Maintain Momentum Amid Headwinds?

A. O. Smith Corporation AOS has impressed investors with its recent earnings streak, having surpassed estimates thrice in the four trailing quarters. Further, the company’s leading position in water heating equipment and water treatment product markets, improved product mix and robust liquidity position bode well for future growth.

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

Factors to Consider

The company's replacement market, which accounts for approximately 85% of the North American water heater and boiler volumes, has been witnessing an uptrend, thus stoking growth. For 2018, the company believes that the water heater volumes in the U.S. residential industry will shoot up 250,000-300,000 units. The volume growth will be largely driven by higher replacement demand and new construction. Also, the company expects revenues from its boiler business to grow roughly 10% in 2018.

Moreover, A. O. Smith’s business in China has grown significantly over the years. The water heater market in the country is expected to be fuelled by factors like growth of households, market share gain, geographic expansion and improved product mix. For full-year 2018, sales in China are anticipated to improve 3% in local currency. However, slowdown in housing sales and international trade issues will play spoilsport.

Further, the company dedicatedly follows a capital deployment strategy and continually rewards its shareholders via repurchases and dividend increases. At the end of third-quarter 2018, A. O. Smith had roughly 3.2 million shares remaining under repurchase authority. Recently, it hiked quarterly dividend rate by 22%. This initiative will enable the company to retain investors’ confidence in the stock.

In the past month, the Zacks Rank #3 (Hold) company has lost 0.1% compared with the industry’s decline of 3.5%.

However, higher selling, general and administrative expenses remain a headwind for A. O. Smith. Higher developmental costs associated with new products, including expansion of air purification product portfolio, are driving its operating expenses.

In addition, market prices for certain raw materials used by the company, primarily steel, have been subject to volatility. Steel prices in particular have been on the rise since February, and are expected to continue the uptrend. Rising steel costs are predicted to a major headwind in 2018, impacting margins.

Key Picks

Some better-ranked stocks in the same space are Enersys ENS, Applied Industrial Technologies, Inc. AIT and Cintas Corporation CTAS. While Enersys sports a Zacks Rank #1 (Strong Buy), Applied Industrial Technologies and Cintas carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Enersys exceeded estimates thrice in the preceding four quarters, the average positive earnings surprise being 2.83%.

Applied Industrial Technologies surpassed estimates in the trailing four quarters, the average positive earnings surprise being 11.67%.

Cintas outpaced estimates in the preceding four quarters, the average earnings surprise being 7.22%.

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