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Bear of the Day: AO Smith (AOS)

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Today’s Bull of the Day is a company that’s doing a great job in the relatively boring apparel and footwear industry. Manufacturing water heating equipment could well be the same sort of story. It’s not exciting by any means, but virtually every business and residence across the country has some sort of hot water heater. Because of the destructive nature of water on mechanical equipment, they need to be repaired or replaced on a regular basis.


Unfortunately, Milwaukee-based AO Smith (AOS - Free Report) hasn’t been able to capitalize lately on their position as the largest manufacturer in the industry and their exposure to Asian markets and manufacturing makes them vulnerable to trade-related issues.


Founded in 1874 and originally a manufacturer of bicycle parts, AO Smith made a series of strategic acquisitions between the 1940’s and 2010 and ended up one of the world’s largest producers of gas, propane, electric, tankless and solar hot water heaters.


A diverse geographic presence can have a diversifying effect on business, but it also comes with a host of unique risks involving currency, interest rates, shipping and materials costs that don’t affect purely domestic companies. The recent strength of the US Dollar has been particularly damaging to sales in Asia.


Slowing global sales and rising materials costs helps contribute to a negative earnings picture for AO Smith. Tariffs on Aluminum and Steel have further hurt results.


In a competitive industry, AO Smith doesn’t have the pricing power to pass along tariff and trade related shipping costs along to customers, resulting in lowered revenues and guidance. AO Smith shares currently trade more than 25% off of 2018 highs.


Reporting net earnings of $0.53/share in the most recent quarter – a slight miss of the Zacks consensus Estimate of $0.54/share – CEO Kevin Wheeler described the Chinese market as “challenging” and noted that sales and earnings declines in the region more than offset gains in the North American market.


Net earnings were 13% lower than the year-ago period.


Eight analyst downward revisions in the past 7 days earn AO Smith a Zacks Rank #5 (Strong Sell). Full year 2019 and 2020 earnings estimates have been reduced approximately 4% each over that period.


Low interest rates, a healthy housing market and a stable of globally recognized products seem like they ought to add up to improved performance at AO Smith, but headwinds in international trade and finance are holding the company back.


It’s not a story of poor management or decisions, but unfortunately, AO Smith is simply on the wrong end of global trends that may not be worked out anytime soon.


In the manufacturing industry, AZZ Inc (AZZ - Free Report) – a Zacks rank #1 (Strong Buy) – is a better choice for sensible investors.


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