Acquiring Pureit And New Facilities Will Strengthen Water Treatment In India And Globally

Key Takeaways

• Acquiring Pureit from Unilever and expanding in India could boost A. O. Smith's premium water treatment revenues and distribution reach.
  
• New facilities, product innovations, and cost-saving efforts in various regions aim to expand market share and improve margins.
  
• Declining sales and order rates, particularly in China and North America, coupled with inventory issues, could negatively impact revenue, margins, and financial flexibility.

Catalysts

Manufactures and markets residential and commercial gas and electric water heaters, boilers, heat pumps, tanks, and water treatment products in North America, China, Europe, and India.

• The acquisition of Pureit from Unilever is expected to enhance A. O. Smith's premium water treatment product portfolio and distribution footprint, particularly in India, leading to potential revenue growth.
  
• The opening of a new facility in Juarez to manufacture gas tankless water heaters and increase heat pump capacity could drive revenue and margin expansion in North America as production starts in early 2025.
  
• The introduction of additional tankless product models in early 2025 and the innovative design features of these products target increased market share and revenue growth in North America.
  
• Expansion projects, including a new commercial product development center in Livingston, Tennessee, aiming to improve product innovation and testing capabilities, could support revenue growth and potentially improve net margins.
  
• Ongoing cost-saving projects in China and the strategic review of operations to align with lower volumes are expected to enhance net margins and earnings by optimizing costs against a backdrop of weaker demand.

A. O. Smith Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming A. O. Smith's revenue will grow by 2.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 14.4% today to 15.4% in 3 years time.
• Analysts expect earnings to reach $647.9 million (and earnings per share of $4.7) by about January 2028, up from $561.2 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.1x on those 2028 earnings, up from 18.1x today. This future PE is greater than the current PE for the US Building industry at 20.5x.
• Analysts expect the number of shares outstanding to decline by 1.68% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.24%, as per the Simply Wall St company report.

A. O. Smith Future Earnings Per Share Growth

Risks

• The decline in third-party sales in China by 17% in local currency due to weaker-than-expected consumer demand and increased pricing and promotional pressure could negatively impact revenue and earnings if trends persist.
  
• North America water heater sales decreased by 4%, primarily due to lower volumes, which could result in reduced revenue and pressure on net margins if market softness continues.
  
• The challenges with the new tankless water heater product, including sales lagging expectations, could impact future revenue growth and profit margins if the rollout does not recover as anticipated.
  
• Increasing inventory balances and adjustments in customer order patterns, along with reduced customer deposits in China, have led to a decrease in free cash flow, negatively impacting liquidity and financial flexibility.
  
• The weakened order rates in the residential boiler market and slower quoting activity in the commercial segment may suppress expected sales growth and segment margins if these trends continue.

Valuation

• The analysts have a consensus price target of $80.99 for A. O. Smith based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $95.0, and the most bearish reporting a price target of just $64.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $4.2 billion, earnings will come to $647.9 million, and it would be trading on a PE ratio of 21.1x, assuming you use a discount rate of 7.2%.
• Given the current share price of $69.87, the analyst's price target of $80.99 is 13.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.