High-Efficiency Water Solutions And Emerging Market Demand Will Drive Powerful Long-Term Upside

Catalysts

About A. O. Smith

A. O. Smith manufactures and markets water heaters, boilers and water treatment solutions for residential, commercial and industrial customers worldwide.

What are the underlying business or industry changes driving this perspective?

• Accelerating adoption of high efficiency commercial water heaters and boilers, including the Flex platform and CREST units, positions A. O. Smith to outgrow a resilient replacement driven market and lift revenue and operating margins through premium pricing and mix.
• Structural growth in water quality and purification demand in India and other emerging markets, combined with the Pureit acquisition and strong double digit local growth, expands the addressable market for water treatment and supports sustained top line growth and higher consolidated earnings.
• Ongoing operational excellence initiatives, including production efficiency, footprint optimization and disciplined tariff mitigation, are already expanding segment margins and should compound into structurally higher net margins and free cash flow conversion.
• Strength in higher value channels such as dealers, e commerce and direct to consumer in North America water treatment, which are growing double digits as lower margin retail is deemphasized, should enhance mix, support steady revenue growth and deliver the targeted operating margin expansion.
• Increased investment in digital capabilities and innovation, led by a new Chief Digital Information Officer and CTO, is expected to unlock productivity, accelerate new product commercialization such as gas tankless and smart connected solutions, and support multi year growth in sales and earnings.

Assumptions

This narrative explores a more optimistic perspective on A. O. Smith compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming A. O. Smith's revenue will grow by 4.5% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 13.9% today to 15.1% in 3 years time.
• The bullish analysts expect earnings to reach $660.7 million (and earnings per share of $4.9) by about December 2028, up from $530.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 23.6x on those 2028 earnings, up from 18.0x today. This future PE is greater than the current PE for the US Building industry at 20.2x.
• The bullish analysts expect the number of shares outstanding to decline by 3.28% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.35%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistent economic weakness and subsidy rollbacks in China, combined with intensifying discount driven competition, could turn what is currently a 10% annual sales decline in local currency into a prolonged structural downtrend. This could cap consolidated revenue growth and limit Rest of World earnings contribution over the long term.
• Rising and volatile tariff and input costs, including steel increasing by 15% to 20% in the second half of 2025 and tariffs expected to lift cost of goods sold by about 5%, may outpace the company’s ability to push through sustainable price increases. This could compress segment margins and ultimately net margins and earnings.
• Secular pressure on residential new construction, particularly in multifamily housing in the U.S., alongside any deterioration in consumer confidence or proactive replacement behavior, could move the currently flat to slightly down residential water heater market into a sustained decline. This could constrain top line growth and leave less operating leverage to support earnings expansion.
• The strategic shift away from lower margin retail in North America water treatment and the integration of Pureit, which is expected to be a near term headwind, might take longer than planned to reach the targeted 250 basis point margin uplift. This could delay mix improvement benefits and weigh on revenue growth and consolidated operating margins.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for A. O. Smith is $97.35, which represents up to two standard deviations above the consensus price target of $78.5. This valuation is based on what can be assumed as the expectations of A. O. Smith's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $100.0, and the most bearish reporting a price target of just $62.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be $4.4 billion, earnings will come to $660.7 million, and it would be trading on a PE ratio of 23.6x, assuming you use a discount rate of 8.4%.
  
• Given the current share price of $68.72, the analyst price target of $97.35 is 29.4% 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.