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Why A. O. Smith Stock Jumped 12% in May

By Reuben Gregg Brewer – Updated Jun 3, 2020 at 8:50AM

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Things looked really bad for A. O. Smith as the year got underway, but there are glimmers of hope that the worst is past.

What happened

Shares of water heater maker A. O. Smith (AOS -0.31%) rose roughly 12% in May according to data from S&P Global Market Intelligence. That easily beat the approximately 4.5% advance in the S&P 500 Index during the month. That said, 2020 hasn't been a great one for A. O. Smith overall, with the stock essentially breaking even through the first five months of the year. With solid gains in April and May, it has only managed to claw its way back from a deep decline that started in January and ended in March. The broader market, for reference, didn't start to fall until late February. There's some valuable information in the time differences here.

So what

A. O. Smith has two main markets, North America and China. When the company reported first-quarter earnings the differences between these two businesses were pretty stark. North American sales, which are largely driven by the replacement of older products, were up 2%. The "rest of world" segment, where sales are almost all attributable to its business in China, saw a revenue drop of 53%. Rest of world represented roughly a third of the company's sales in 2019, so this decline is a pretty big deal.   

A man sitting in front of computer screens with stock information on them

Image source: Getty Images

The reason for the drop off is two-fold. First, demand for A. O. Smith's products in China is mainly driven by new construction. Second, China was the first country to be impacted by COVID-19. As the giant Asian country shut vast regions down to slow the spread of the disease caused by a novel coronavirus, construction pretty much came to a standstill along with the rest of the economy. And since replacing broken water heaters isn't a big demand issue (which would likely be seen as a necessity purchase), A. O. Smith's business in that country quickly declined. 

However, China has begun to reopen and demand has picked up. This is good news for A. O. Smith's rest of world segment, but there's an even bigger picture here. The company's North American business is getting hit right now (though probably not as badly because of the replacement nature of the water heater market in the region), but once the economies in the region start to reopen again, as happened in China, demand will likely recover. In other words, to quote an old proverb, this too shall pass.   

Now what

COVID-19 is terrible, but A. O. Smith, via its Chinese business, has proven it can weather the hit. Long-term investors should keep this in mind as they watch second-quarter earnings, which will show the impact that the coronavirus has had on the North American business. However, it's also important to remember that A. O. Smith is a cyclical company. Since the efforts to contain the spread of COVID-19 are likely to push the North American region into a recession, the bad news here probably isn't over yet. Still, if A. O. Smith can weather COVID-19, it's highly likely to muddle through a recession in relative stride, too.

Reuben Gregg Brewer 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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