Please ensure Javascript is enabled for purposes of website accessibility

China Woes Weigh Down A.O. Smith's Q4 2019 Earnings

By John Bromels - Updated Feb 3, 2020 at 5:12PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The top water heater manufacturer is struggling in its key market.

China was front and center on the Q4 2019 earnings call for water heater manufacturer A.O. Smith (AOS -1.85%) on Jan. 28. But for a change, it wasn't about tariffs or the coronavirus; it was all about sales.

About 34% of A.O. Smith's revenue comes from China, so the slowing economy there has materially affected earnings. That trend continued in the most recent quarter, but management seems to think the worst is behind it. 

A smiling man holding a wrench stands next to a water heater

Image source: Getty Images.

A.O. Smith earnings: By the numbers

Metric Q4 2019 Q3 2019 Q4 2018 YOY Change (Decline)
Revenue $750.9 million $728.2 million $812.5 million (7.6%)
Net Income $91.3 million $87.3 million $126.3 million (27.7%)
Earnings per Share $0.56 $0.53 $0.74 (24.3%)

YOY = year over year. Data source: A.O. Smith. Chart by author.

Although revenue, net income, and earnings per share crept up slightly from Q3, they were way down versus the year-ago quarter. The company divides its operations into two divisions: North America and Rest of World. The biggest factor in the underperformance was the Rest of World segment, where net income fell so much as to be virtually nonexistent:

A bar chart of A.O. Smith's segment performance

Data source: A.O. Smith. Chart by author.

Focus on China

The vast majority of A.O. Smith's overseas sales (about 94.3%) are from China. Unfortunately, thanks to unfavorable currency headwinds, a slowing economy, and a product mix that consisted of more lower-margin midprice models, China sales fell 19% in 2019, to about 29.4% of overall revenue.

Sales in the company's only other overseas market of any significance, India, actually grew by 13% in 2019, but India makes up only about 2.4% of overall sales. Which means that A.O. Smith has to either boost North American sales to make up for the Chinese losses, or figure out how to reverse the trend in China.

On the earnings call, management said that its elevated inventory levels in China have already returned to normal, and that it anticipates a 2.5% increase in China sales, which will drop to a 1% increase in U.S. dollars after currency effects are factored in.

What management had to say

CEO Kevin Wheeler acknowledged that China sales were a problem, but said the company had been taking steps not only to turn things around in its top overseas market, but also to boost sales in North America:

In 2019, we laid the groundwork for future success with several activities. An acquisition was added to our North America water treatment portfolio; China channel inventory levels declined, to be within the normal range of two to three months; we substantially completed our re-entry into the high-end of midprice-range products in China with new products specifically designed to target this demographic; and full implementation of our enterprise resource planning environment in North America is nearly complete. In 2020, we look forward to building from these actions.

The outlook

Wheeler announced guidance for 2020 revenue growth between 4.5 and 5.5 percent, which wouldn't quite erase 2019's 6% decline in revenue from 2018. He projected 2020 per-share earnings between $2.40 and $2.50, which would represent an increase between 8.1% and 12.6% over 2019. But he cautioned that the guidance excluded the potential impact of the coronavirus, which has been causing travel disruptions and economic uncertainty in China that have rippled around the globe.

In good news for dividend investors, the company has already announced a quarterly dividend increase of 9%, to $0.24 a share, continuing a long string of annual dividend increases for the company. This bumps the yield to 2.1%, the highest in 10 years. 

A.O. Smith has low debt and is currently priced attractively at 19.5 times earnings, which is near the low end of its range. Problems in China may limit the company's growth in the near term, but value investors may want to keep it on their radar screen.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

A. O. Smith Corporation Stock Quote
A. O. Smith Corporation
AOS
$58.90 (-1.85%) $-1.11

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
345%
 
S&P 500 Returns
119%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/16/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.