A. O. Smith Corporation (AOS Quick QuoteAOS - Free Report) has failed to impress investors with its recent operational performance due to persistent weakness in the Rest of the World segment. Also, increasing expenses are likely to impede the company’s earnings in the quarters ahead.

Headquartered in Milwaukee, WI, A. O. Smith is one of the leading manufacturers of commercial and residential water heating equipment and water treatment products of the world. The company specializes in offering innovative and energy-efficient solutions and products, which are developed and sold globally.

In the past year, this Zacks Rank #4 (Sell) company’s shares have lost 1.6% against the industry’s 32.6% growth.

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Let’s discuss the factors, which are likely to continue taking a toll on this company.

Segment Weakness: Given the nature of its products, the company's fortunes are closely tied to the construction market. Therefore, the ongoing challenges in the Chinese real estate market are concerning for A. O. Smith. Lower volumes of water heaters and water treatment products in the region are challenging for the Rest of the World segment.

A decline in orders for residential and commercial water heater products in the North America segment is also concerning. In the third quarter, the North America segment’s sales declined 1% year over year as higher boiler and water treatment volumes were offset by lower volumes of residential and commercial water heaters.

Increasing Expenses: Rising expenses exert pressure on A. O. Smith’s bottom line. In 2023, the company’s selling, general and administrative (SG&A) expenses increased 8.4% year over year. The metric, as a percentage of sales, increased 80 basis points. The trend appears to be continuing this year, as both costs of sales and SG&A expenses remain on an uptrend. 

The company’s cost of sales was $1.8 billion in the first nine months, up 2.2% year over year due to higher material costs. SG&A expenses were up 2.8% year over year.  The increase was attributable to higher employee costs from increased wages and management incentives. The company's raw material costs primarily depend on steel prices, which are subject to fluctuations over time. Any increase in cost that does not generate sales growth would directly impact margins and profitability.

Forex Woes: A. O. Smith has a significant presence in Asian countries like China and India. Since its products are priced in the local currencies of these countries, any increase in the value of the U.S. dollar relative to the local currencies would impact its revenues and profitability. For example, adverse foreign currency movements lowered the Rest of the World segment’s revenues by $2 million in the third quarter and $44 million in 2023. The company predicts an adverse foreign exchange impact of approximately 1% for 2024 on China sales. Interest rate fluctuation and hyperinflation in some countries further increase uncertainties.

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