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A.O. Smith Is a Water Stock Dividend Growth Machine

water resources

(Anton Skavronskiy/Dreamstime)

Tuesday, 13 August 2019 11:59 AM Current | Bio | Archive

Water: Something Everyone Needs 

Investors frequently want to own stock in companies that offer a service that customers can’t do without. Given that water is something that everyone needs, companies with exposure to this precious resource could offer high rates of returns.

One of our favorite water industry companies is A.O. Smith Corporation (AOS).

Company Background and Recent Results

Founded in the 1870s, A.O. Smith is a leading manufacturer of residential and commercial water heaters, boilers, and water treatment products. The company operates primarily in two major markets: North America and China. A.O. Smith has a market capitalization of $7.5 billion, with annual revenues approaching $3.2 billion.

A.O. Smith reported financial results for the second quarter on 7/30/2019. The company earned $0.61 per share, which was $0.02 below estimates and a 7.6% decline from the previous year. Revenue decreased 8.2% to $765.4 million.

North American sales decreased 2% to $524 million driven by lower residential water heater volumes compared to the second quarter. It should be noted that the second quarter of 2018 saw additional purchases as customers were motivated to purchase ahead of price increases. These price increases did help to offset volume declines in the most recent quarter and resulted in flat segment margins of 23.5%.

Revenues for the Rest of World segment were down 19% to $249.1 million. China sales declined 16% in local currency, in large part due to the previously mentioned inventory build. A weaker currency also impacted China results. Trade concerns between the U.S. and China also continue to hamper A.O. Smith’s business in the country. India sales improved 30%. Overall, segment margins declined 230 bps to 9%.

A.O. Smith expects that China sales will continue to be weak and has lowered its midpoint for expected EPS in 2019 to $2.38, down from $2.72 previously.

A.O. Smith has compounded EPS at a rate of 18% over the past decade, but given the importance of China to the company’s business, we feel an EPS growth rate of 9% through 2024 is more likely to occur.

Dividends, Valuation and Total Returns

A.O. Smith has increased its dividend for the past 25 years. This makes A.O. Smith one of the newest companies to join the Dividend Aristocrats, an exclusive group of stocks that have increased their dividends for at least 25 consecutive years. You can see all 57 Dividend Aristocrats here.

A.O. Smith currently yields just 1.9%, but don’t let that low yield fool you. The company has aggressively grown its dividend over the years.

The company has increased its dividend:

  • With a CAGR of 16.6% per year for the past three years
  • With a CAGR of 20.4% per year for the past five years
  • With a CAGR of 19.3% per year for the past 10 years

A.O. Smith increased its dividend 22.2% for the payment made 11/15/2018.

Even better, the dividend is well-covered. Using the annualized dividend of $0.88 and the company’s updated EPS guidance of $2.38, the dividend payout ratio is just 37%.

Shares of A.O. Smith closed the 8/12/2019 trading session at $45.50. Using updated EPS guidance for the year, the stock has a P/E ratio of 19.1. The stock has traded with a P/E ratio of above 20 for much of the last decade. Due to slowing business, we feel more comfortable with 2024 P/E target of 20.

If the stock were to trade at this P/E ratio by 2024, then valuation would add ~1% to annual returns over this period of time.

Annual returns would thus consist of the following:

  • 9% EPS growth
  • 1.9% dividend yield
  • 1% multiple expansion

Added up, we expect that A.O. Smith will offer a total annual return of 11.9% through 2024.

Final Thoughts

A.O. Smith’s business saw declines in each of its major markets in the most recent quarter. Some of this weakness was due to higher sales due to upcoming price increases in the previous year. Trade tensions with China will likely to impact the company going forward.

Still, A.O. Smith offers double-digit growth potential over the next five years. Investors looking for exposure to the water industry could do well owning this Dividend Aristocrat. A.O. Smith receives a buy recommendation from Sure Dividend at this time.


Ben Reynolds
Sure Dividend

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A.O. Smith offers double-digit growth potential over the next five years. Investors looking for exposure to the water industry could do well owning this Dividend Aristocrat. A.O. Smith receives a buy recommendation from Sure Dividend at this time.
eps, expansion, cagr, aos
Tuesday, 13 August 2019 11:59 AM
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