A.O. Smith (NYSE: AOS), North America's largest manufacturer of electric motors, shocked investors this morning by drastically reducing third-quarter earnings guidance to breakeven -- after saying as late as July 15 that earnings would be up to $0.46 a share. The company also cut full-year guidance almost in half.
The stock took a pounding, losing 15% of its value on its way to being the NYSE's biggest percentage loser.
The principal drivers to the shortfall were an "unprecedented increase" in steel costs, cost increases in "other materials," and high freight costs. But the problems also included reduced sales at the Water Systems business and lower production volumes at the Ashland City, Tenn., plant. All in all, this is not a pretty picture.
A.O. Smith's performance looks downright pitiful compared with competitor Emerson Electric (NYSE: EMR), where the latest earnings (up 23%) exceeded analyst expectations and the company boosted full-year guidance.
The company's operating margins, a narrow 4.7%, also look poor when compared with Emerson's 12.6% and General Electric's (NYSE: GE) 11.1%. With narrow margins, accelerating costs (or falling sales) can quickly change profits into losses.
Emerson and GE are producing free cash flow and selling for the same 21 times 2004 estimated earnings as free-cash-flow-negative A.O. Smith. No wonder Smith's shares got pounded.
A.O. Smith expects to raise prices and restore its profitability. Consider, though, what was said last quarter: "The company has implemented several price increases during the last four months, and these increases are now taking effect and mitigating the adverse impact of the higher steel and freight costs." Yikes! Talk about missing the mark.
A steady stream of price increases is always risky. Given the magnitude of the company's inability to forecast earnings, and its low margins, there are better investment alternatives.
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Fool contributor W.D. Crotty does not own stock in any of the companies mentioned.
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