Dividend Stock Analysis – AOS

[Wow, two posts in one day, right?]

Welcome to a new stock analysis from DividendDeveloper! My goal in analyzing stocks on this blog is twofold. First, I want to check if a given stock meets my criteria for investing, and if it would make a good investment. Second, I want to expose my readers to companies that they may not have encountered before, whether because the company’s dividend yield is too low, their streak of increasing dividends is not long enough, or it just slipped through the cracks of their screeners.

The company that I will be looking at today is the A. O. Smith Corporation (NYSE:AOS).

Quick Background:

Quoting from the 2013 annual report:

A. O. Smith Corporation is a leading diversified provider of innovative, energy efficient products to heat and clean water. The company is one of the world’s leading manufacturers of residential and commercial water heating equipment and boilers, offering a comprehensive line featuring the best-known brands in North America, China, and India. It also manufactures water purification products for residential and light commercial applications.

Founded in 1874 in Milwaukee, Wisconsin, AOS has paid dividends every year since 1940. The company’s brands include A.O. Smith Water Products, American Water Heaters, GSW, John Wood, and Takagi. The company operates in 2 segments: North America (69% of revenues) and Rest of World (31% of revenues); China and India make up 91% of the Rest of World segment. AOS owns slightly over 40% of the North American market; the next largest competitors own about 30% (Rheem) and 20% (Bradford White). The company is making serious strides into energy efficiency, such that the US government even stated that “all water heaters produced meet the energy savings of an AO Smith water heater”. The company is also expanding heavily in India and China, and is seeing great revenue growth (about 20% annually) therefrom.

For more basic information, check out the company’s website and the above links.

Fun fact: An investment of $10,000 in December 2009 would be worth $50,370.85 today, all dividends reinvested. (Source: FAST Graphs)

Investment Criteria:

So now that we have a basic understanding of who AOS is and what it does, let’s run our basic screening criteria on it, with the help of David Fish’s US Dividend Champions List:

• Pays a dividend: Yes
• Has 5 years of dividend increases: Yes (21 years)
• Has not frozen dividend for over 8 quarters: Yes
• Has a Chowder number of 12 or more: Yes (14.5)
• Has am EPS payout ratio of less than 70%: Yes (28.57%)
• Pays a dividend monthly or quarterly: Yes (Quarterly; January, April, July, October)

Awesome, all initial screening criteria appear to be met! Let’s pull up FAST Graphs and see how AOS fares in round two:

• Has an S&P Quality Ranking of ‘A-‘ or better: Yes (A-)
• Has generally increasing earnings over the past 10 years: Yes ($1.83 for 2013, $0.58 for 2003; source)
• Is fairly valued/undervalued according to the Normal P/E ratio (blue line): No
• Is fairly valued/undervalued according to the Intrinsic P/E ratio (orange line): Yes

Other Bonus Ratings:

• S&P Capital IQ: 3-star hold
  • Scale is 1-5, 1 being ‘strong sell’, 5 being ‘strong buy’
• Thompson Reuters StockReport: 8 (optimized score of 7)
  • Scale is 1-10, 10 being best, 1 being worst
  • Optimized scores weight insider trading and price momentum heavier than other criteria
• Value Line: 3 for safety; 3 for timeliness
  • Scale is 1-5, 1 being best, 5 being worst

Thoughts:

The dividend yield is nothing special at 1.2%, with an annual payout of $0.60. The 10 year average dividend growth rate is 9.1%, but the company seems to be taking the dividend a bit more seriously in the past few years. The 5 year growth rate is 13.3%, the 3 year is 19.4%. The last increase was in January, a 25% increase! On top of that, the stock has split 4 times, in 1993 (2-for-1), 1998 (3-for-2), 2010 (3-for-2), and 2013 (2-for-1).

The P/E ratio currently appears mildly elevated at 22.54, but Morningstar has a 1-year forward P/E ratio of 17.6, showing good growth in earnings ahead, mostly from the above-mentioned international expansion.

Gross margins are impressive at 36.05% while the net profit margin is 8.59%, both above the peer group’s average of 27.45% and  6.83%, respectively. (Source: Scottrade)

Debt is not much of a concern, as their debt-to-equity ratio is only .18. The company is sitting on $486 million in cash and cash equivalents, and has only $191.9 million in debt, which implies a very solid balance sheet. (Source)

I find it interesting that the market places a lower value overall on shares on AOS, possibly as a result of it being in the slow moving Industrials category. However, for the next five years, it’s projected that earnings will grow 14.3%, and the estimated total return is 8.4%, which is neither outstanding nor terrible. For comparison, GE’s ETR is 9.9%, EMR’s is 10.3%, and MMM’s is 7.6%. (Source: FAST Graphs)

Some good SeekingAlpha articles on AOS can be found here and here, which help illustrate AOS’s higher growth rates and future prospects.

 Final conclusion:

I believe AOS is an attractive investment. It may be in a slower-growing industry, but their dominant market share and steady upward growth (due to international expansion) look promising. Since people like price points, so here’s what I would do (rough estimates based on FAST Graphs):

• Buy a full position at: $35.00 or below
• Add to/accumulate between: $35.00 and $60.00
• Hold only at:  $60.00 or above

What do you think? Does AOS make the cut for your portfolio? Also, how can I improve future analyses?

Disclosure: None.

All data is accurate as of market close, 09/30/2014. My stock analysis archive page has been updated accordingly. Please read my disclaimer here before choosing to invest. Image source is available here. Data source is FAST Graphs or company materials, unless otherwise indicated.

Tags: A.O. Smith, AOS, dividend-stock-analysis