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A. O. Smith (AOS) Braves Headwinds on Solid Growth Drivers

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On Oct 3, we issued an updated research report on A. O. Smith Corporation (AOS - Free Report) .

Let’s delve deeper to find out the key factors that are likely to influence its operational performance moving ahead.

Existing Scenario

A. O. Smith is well positioned to gain from strength in its defensive replacement market, which sets it apart from its peers. Also, the company believes in adding complementary businesses to its portfolio via acquisitions. Notably, the buyout of Water-Right (completed in April 2019) is likely to boost the company’s growth opportunities in the water treatment market, especially in the wholesale and independent dealer array. In addition, its buyout of Aquasana (closed in 2016) has been enhancing its global water treatment business and providing a solid direct-to-consumer platform.

Moreover, A. O. Smith’s robust liquidity position adds to its strength. The company had cash balance of about $578 million located offshore and net cash position of approximately $219 million at the end of second-quarter 2019. Also, the company dedicatedly follows a capital deployment strategy and continually rewards its shareholders via repurchases and dividend increases. In the first six months of 2019, it bought back 2.8 million shares for $132.6 million. It’s worth noting here that in October 2018, it hiked quarterly dividend rate by 22%.

However, weakness in the company’s North America segment due to soft sales of residential water heater volumes remains a concern. Going forward, A. O. Smith believes that higher steel prices, softer sales of water heaters, water treatment products and air purifiers in China will adversely impact its results. As a matter of fact, the company expects persistent weakness in China (on account of lower consumer demand) for the rest of 2019. Sales in the country are predicted to fall 16-17% (in local currency term) for 2019.

Further, high capital expenditure is likely to adversely impact its short-term earnings. Also, corporate expenses are expected to be $49 million in 2019, higher than $47 million in 2018, primarily on account of inflation. These are expected to put pressure on its near-term profitability. In addition, market prices for certain raw materials used by the company, primarily steel, are expected to continue rising, posing a major headwind for 2019. Further, A. O. Smith faces strong competition in all of its product categories. Its major peers include Emerson Electric Co. (EMR - Free Report) , Panasonic Corporation (PCRFY - Free Report) and Pentair plc (PNR - Free Report) .

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