Water heating and treatment solutions company A.O. Smith (NYSE:AOS) missed Wall Street’s revenue expectations in Q3 CY2024, with sales falling 3.7% year on year to $902.6 million. Additionally, the company’s full-year revenue guidance was lowered. Its non-GAAP profit of $0.82 per share was in line with analysts’ consensus estimates.
Revenue: $902.6 million vs analyst estimates of $957.8 million (5.8% miss)
Adjusted EPS: $0.82 vs analyst expectations of $0.82 (in line)
The company dropped its revenue guidance for the full year to $3.85 billion at the midpoint from $4.01 billion, a 4% decrease
Management lowered its full-year Adjusted EPS guidance to $3.78 at the midpoint, a 6.2% decrease
Gross Margin (GAAP): 37.4%, in line with the same quarter last year
Free Cash Flow Margin: 18.1%, up from 17.1% in the same quarter last year
Market Capitalization: $11.46 billion
Company Overview
Credited with the invention of the glass-lined water heater, A.O. Smith (NYSE:AOS) manufactures water heating and treatment products for various industries.
HVAC and Water Systems
Many HVAC and water systems companies sell essential, non-discretionary infrastructure for buildings. Since the useful lives of these water heaters and vents are fairly standard, these companies have a portion of predictable replacement revenue. In the last decade, trends in energy efficiency and clean water are driving innovation that is leading to incremental demand. On the other hand, new installations for these companies are at the whim of residential and commercial construction volumes, which tend to be cyclical and can be impacted heavily by economic factors such as interest rates.
Sales Growth
Reviewing a company’s long-term performance can reveal insights into its business quality. Any business can have short-term success, but a top-tier one sustains growth for years. Over the last five years, A. O. Smith grew its sales at a tepid 5% compounded annual growth rate. This shows it failed to expand in any major way and is a rough starting point for our analysis.
A. O. Smith Total Revenue
Long-term growth is the most important, but within industrials, a half-decade historical view may miss new industry trends or demand cycles. A. O. Smith’s recent history shows its demand slowed as its annualized revenue growth of 1.1% over the last two years is below its five-year trend.
This quarter, A. O. Smith missed Wall Street’s estimates and reported a rather uninspiring 3.7% year-on-year revenue decline, generating $902.6 million of revenue.
Looking ahead, sell-side analysts expect revenue to grow 2% over the next 12 months, similar to its two-year rate. This projection doesn't excite us and indicates the market thinks its newer products and services will not lead to better top-line performance yet.
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Operating Margin
Operating margin is one of the best measures of profitability because it tells us how much money a company takes home after procuring and manufacturing its products, marketing and selling them, and, most importantly, keeping them relevant through research and development.
A. O. Smith has been a well-oiled machine over the last five years. It demonstrated elite profitability for an industrials business, boasting an average operating margin of 17.4%. This result isn’t surprising as its high gross margin gives it a favorable starting point.
Looking at the trend in its profitability, A. O. Smith’s annual operating margin rose by 6 percentage points over the last five years, showing its efficiency has meaningfully improved.
A. O. Smith Operating Margin (GAAP)
Earnings Per Share
Analyzing long-term revenue trends tells us about a company’s historical growth, but the long-term change in its earnings per share (EPS) points to the profitability of that growth – for example, a company could inflate its sales through excessive spending on advertising and promotions.
A. O. Smith’s EPS grew at a decent 9.8% compounded annual growth rate over the last five years, higher than its 5% annualized revenue growth. This tells us the company became more profitable as it expanded.
A. O. Smith Trailing 12-Month EPS (Non-GAAP)
A. O. Smith Diluted Shares Outstanding
We can take a deeper look into A. O. Smith’s earnings quality to better understand the drivers of its performance. As we mentioned earlier, A. O. Smith’s operating margin expanded by 6 percentage points over the last five years. On top of that, its share count shrank by 11.4%. These are positive signs for shareholders because improving profitability and share buybacks turbocharge EPS growth relative to revenue growth.
Like with revenue, we analyze EPS over a shorter period to see if we are missing a change in the business. For A. O. Smith, its two-year annual EPS growth of 10.4% is similar to its five-year trend, implying stable earnings power.
In Q3, A. O. Smith reported EPS at $0.82, down from $0.90 in the same quarter last year. This print was close to analysts’ estimates. Over the next 12 months, Wall Street expects A. O. Smith’s full-year EPS of $3.84 to grow by 3.6%.
Key Takeaways from A. O. Smith’s Q3 Results
Revenue missed and the company lowered its full year guidance for revenue and EPS. Overall, this was a bad quarter. The stock remained flat at $78.06 immediately after reporting.
