Dividend Stock Review of A.O.Smith Corp (AOS)

A. O. Smith Corp (AOS) is a Dividend Champion with an impressive 26-year history of increasing their dividends.  The last increase came in October 2019 when they increased their dividend by 9.1%.

AOS manufactures water heating equipment and air purification products. They operate through two segments: North America and the Rest of the World. The North America segment manufactures and markets comprehensive lines of residential and commercial gas and electric water heaters, boilers, tanks. The Rest of the World segment comprises of China, Europe, and India; and manufactures and markets water treatment products.

Leadership

Kevin Wheeler was named to lead the company’s water heating operations in the U. S., Canada, Mexico, Europe, and India in September 2011. He has profit and loss responsibility for the 11 brands that make up this business unit. The unit’s operations include 13 facilities and more than 3,800 employees. Kevin was named Senior Vice President and General Manager of A. O. Smith’s U. S. Retail Water Heaters in May 2007, responsible for the company’s retail Strategic Business Unit including the Whirlpool, Kenmore, U.S. Craftmaster, and Reliance brands.

He joined A. O. Smith as a regional sales manager for its Water Products Company division in 1994. He also served as Managing Director of the Company’s Veldhoven, the Netherlands, operation, and as Vice President-International, responsible for the company’s residential and commercial water heating business outside the United States and Canada. Prior to joining A. O. Smith, Wheeler held sales management positions with American Water Heater Company of Johnson City, and Bradford-White Corporation, a water heater manufacturer headquartered in Ambler, Pa

Business Analysis

A.O. Smith is a global leader providing innovative and energy-efficient products used to heat, treat, and conserve water. They manufacture a variety of residential and commercial water heatings and boilers, as well as water treatment systems. A.O. Smith operates in two operating segments, separated by geography: North America and ROW.

In 2019, North American provided 69% of sales which is a 5% increase from 2018. The Rest of the world provided 31% of Sales. The company has a healthy international presence, particularly in China where it holds just over a 20% Market share in water heaters and Water Treatment systems. Online shopping is growing with 31% of sales coming from e-commerce in 2019.  Urbanization in China is projected to drive 28% of all global growth.

The company is building a presence in India, the second most populous country in the world since 2008.This business represents approximately 2% of total sales however India will not achieve break-even in 2020.

Company Growth

A.O. Smith has performed very well over the past 10 years, The company’s sales have grown at a 8% average over the past 10 years.

In the same 10-year period, adjusted earnings-per-share increased 21% per year.

Earnings Release

On the 5^th May AOS released first-quarter net earnings of $51.7 million or $0.32 per share on first-quarter sales of $636.9 million. Earnings per share declined 40 percent compared with first-quarter 2019 earnings per share of $0.53. Sales in the quarter ended March 31 were approximately 15 percent lower compared with sales of $748.2 million during the same period in 2019. This was to be expected due to the current Covid-19 pandemic.

 As of April 30, 2020, the Company had liquidity of approximately $850 million consisting of cash, cash equivalents, marketable securities, and undrawn borrowing capacity on its credit facility. The Company’s leverage ratio was 17.5 percent as measured by total debt to total capitalization at the end of March.

Cuts

Board members and the chief executive officer of the Company have voluntarily reduced their cash component of board compensation and his base salary, respectively, by 25 percent. In addition, the Company’s other named executive officers and the entire CEO staff have volunteered a 15 percent reduction in base salary.

Given the uncertain business environment, the Company suspended its share repurchase program in mid-March.  During the first quarter of 2020, the Company repurchased approximately 1.3 million shares of common stock for a total of $57 million.

Dividends

On April 14, the Board of Directors of the Company declared a regular quarterly cash dividend of $0.24 per share on the Company’s Common Stock and Class A Common Stock. The dividend rates remained unchanged from the previous quarterly dividend.

A. O. Smith’s next dividend payment will be US$0.24 per share, and in the last 12 months, the company paid a total of US$0.96 per share. Looking at the last 12 months of distributions, A. O. Smith has a trailing yield of approximately 1.94% on its current stock price of $49.39.

The Payout Ratio is a good indicator of the sustainability of dividends. AOS has a modest 40% payout ratio which means there is plenty of room for growth. A good secondary indicator is to evaluate the free cash flow and its another positive for AOS as it only distributed 38.08% of its free cash flow as dividends in 2019.

The dividend looks to be sustainable as it is covered by both the profits and cash flow. This is a nice safety net to have before the dividend would need to be cut.

Dividends Growth

Companies that generate sustainable earnings growth often make the best dividend companies, as it is easier to lift the dividend when earnings are rising. Investors love dividends and I love dividends.

A. O. Smith’s earnings per share have risen 14% per annum over the last five years. Earnings per share have been growing rapidly and the company is retaining a majority of its earnings within the business.

One of the most important factors for me is that a company not only pays a dividend but grows its dividend. Since 2012 they have grown the dividend by over 20% and a long term average of 12.7% from 1999. With growth like this, they have consistently outperformed the dividend growth of the S&P500.

Closing Thoughts

A. O. Smith believes the current environment does not allow it to forecast performance with reasonable precision, and as a result, the Company suspended its 2020 full year outlook.

As the severity and duration of the disruption and pace of recovery in its end markets become clearer, the Company will look to return to its practice of providing a current year outlook. 

However, there is no denying that AOS has a strong dividend growth track record. They have a healthy balance sheet which looks like it has plenty more room to keep growing those paychecks to investors.

Looking into the future and I am happy to see them trying to expand into fast-growing markets. The company has a long track record of engineering innovation (which is something I admire) and I am confident that AOS can grow their bottom line for years to come. For full disclosure, I am long AOS.

Thanks for reading and Happy Investing!

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