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How China Sent A.O. Smith Stock Tumbling 10.6% in January

By Neha Chamaria – Feb 9, 2020 at 1:30PM

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Is the water heater manufacturer in trouble?

What happened

As an A.O. Smith (AOS -1.37%) user, you may thank the company as much as you want for providing you precious hot showers in this bitter-cold winter. But as a shareholder? Not so much, given the stock's cold start to the year. 

Shares of the water heater manufacturer dropped 10.6% in the month of January, according to data from S&P Global Market Intelligence. China, an otherwise important growth market for A.O.Smith, is largely to blame. In fact, given that A.O. Smith gets a large chunk of sales from China -- 34% in 2018 -- many have invested in the stock to diversify. So when the reason for diversification becomes a reason to worry, investors are bound to be miffed.

So what

On Jan. 28, A.O. Smith announced net income of $370 million for 2019, a substantial drop from its 2018 earnings of $444.2 million. Sales declined 6% to $3.2 billion, driven by a 23% drop in sales from China.

"As expected, sales in China decreased from previous years as elevated channel inventory levels compounded the effects of weaker consumer demand for our products," said Kevin Wheeler, CEO of A.O. Smith. The stock tumbled soon after the earnings release. 

A falling stock market graph arrow on map of China.

Image source: Getty Images.

In hindsight, those numbers shouldn't have really surprised the market, given that management had already projected  a 23% decline in full-year China sales during its third quarter earnings release in October 2019. Yet, A.O. Smith's GAAP EPS of $2.22 fell short of management's forecast range of $2.25-$2.28.

That still makes 2019 the second-most profitable year for the company so far, but investors weren't pleased. 

Or perhaps they don't trust management's 2020 outlook of 4.5%-5.5% growth in sales and 10% growth in EPS at the midpoint. There's reason to be cautious. First, end-user demand in China has been persistently weak for several quarters. Second, the recent coronavirus outbreak adds another layer of uncertainty. Third, management gave out a similar guidance for 2019 at the beginning of 2018, but revised it downward three times since. Investors usually prefer a company that sets the bar low and overdelivers to one that overpromises and falters. 

Now what

It's hard for an A.O. Smith investor not to be worried given the company's reliance on China. At the same time, it's hard to ignore the long-term mega trends that could shape its future, primarily favorable demographics, population growth, and housing development in markets like China and India. Then there are newer growth areas like water treatment and air purification to keep an eye on. 

Importantly, A.O. Smith has the financial fortitude to ride out storms, and investors also have a good dividend to fall back on: the company increased dividend by 9% in 2019 and at a compound average rate of 30% in the past five years.

With the stock yielding 2.2% and trading considerably below its five-year price-to-earning and price-to-cash flow ratios, patience could pay off for shareholders. 

Neha Chamaria has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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