Boring industrial stocks often take a back seat to hot technology names or whatever the in-favor sector is on Wall Street (meme stocks, crypto, etc.). But don't make the mistake of overlooking A. O. Smith (AOS 1.03%).
Yes, it makes boring products, but everyone wants what this company sells and that sets it up for long-term growth for years to come.
The proof is in the dividend
If you want to know just how good A. O. Smith is, take a look at its dividend, which has been increased annually for 31 consecutive years. That qualifies this S&P 500 stock a Dividend Aristocrat. The dividend's compound annual growth rate over the past five years is a massive 17%. And yet the stock price is down 28% so far this year. The dividend yield is just shy of 2%, which isn't exciting on an absolute basis, but is actually near its highest levels over the past decade. That suggests the stock is trading at an attractive price, historically speaking.
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But the really interesting thing about A. O. Smith is what it makes: water heaters. It has smaller businesses in water and air purification, but the big story is hot water. If you live in a developed country that may sound pretty humdrum, but that's because you are used to a reliable supply of hot water. In emerging markets, hot water is not a given.
In-home hot water is in demand and A. O. Smith's growth in recent years has been driven by its expansion in China. Now the company is looking to replicate that success in India.
Huge opportunity on a solid foundation
This industrial's business in developed markets now accounts for around 70% of revenue. It is a solid core, largely driven by replacement demand. That demand is not dependent on economic cycles. If your water heater breaks you are most likely going to be miserable and quickly buy a new one. So this is a reliable core business that provides stable cash flows.
The remaining 30% or so of A. O. Smith's revenue comes largely from foreign sales. China makes up nearly 90% of that figure. That's been a bit of a headwind recently as China's property market is facing financial challenges, including increasing financial strains (and even bankruptcy filings) for some major developers. COVID-19-related lockdowns have also been a drag.
But China was the main growth engine for this water heater maker for years. Assuming China's property market gets back on a regular growth path, this business should stabilize and start to grow again. That said, with a large base of customers now using hot water in China, it is also very possible that this business will start to look more like A. O. Smith's developed markets business over time.
That's why finding another growth engine is so important. And that's most likely going to be India, which only makes up around 4% of A. O. Smith's foreign sales today. Clearly, the company needs to execute as well in India as it did in China if it's going to be a long-term growth driver, but there's no particular reason to believe management will fall flat. In fact, sales in India grew 16% in the third quarter, in local currency, and were the big bright spot in the company's otherwise less-than-stellar recent earnings update. China was weak because of ongoing COVID-related lockdowns and developed markets are working through inventory issues -- both left investors in a dour mood.
Look to the future
While A. O. Smith's stock is down materially so far this year, partly thanks to the bear market and partly thanks to weak developed market results and China, investors should really be focused on the long term. And that's highlighted by still solid demand in India. Given the desirability of hot water, the other businesses are highly likely to turn around, as well. When they do, A. O. Smith will be firing on all cylinders and Wall Street's view of the company will probably change for the better. If you act now, while everyone is focused on the negatives, income investors could end up capturing a bargain price for this reliable dividend grower.
