A.O. Smith (AOS) Rewards Shareholders With 29% Dividend Hike

A. O. Smith Corporation (NYSE:AOS) announced a whopping 29% hike in its quarterly cash dividend. The new dividend of 18 cents per share will be paid on Feb 15 to shareholders on record as of Jan 31.

This translates to a dividend of 72 cents per share on an annualized basis. Based on the current 145.8 million shares outstanding, the new dividend will translate to a total payout of approximately $105 million.

This marks the 13^th consecutive year in which the company has increased its quarterly cash dividend, which underlines the strength and resilience of A.O. Smith’s balance sheet and cash generation. The dividend hike is consistent with the five-year compound annual growth rate of the company’s dividend, which exceeds 25%.

Based on the closing price of $67.04 as of Jan 19, the increased dividend translates to a yield of 1.1%.

With long-term value creation in mind, the company has taken consistent steps to enhance its balance-sheet strength. With a solid capital and liquidity position, the company is anticipated to continue enhancing shareholder value through efficient capital-deployment activities.

Also, A.O. Smith displays strong financial leverage. Its debt/equity ratio of 0.27 compares favorably with the industry average of 0.29, indicating a lower debt burden relative to the industry. The company’s ROE of 22.4% is also much higher than the industry average of 9.7%. This reflects that it is more efficient in utilizing shareholder funds compared to its peers. Moreover, A.O. Smith has appreciated 39.8% in the last year against the 22.4% gain for its industry.

Encouragingly, the company has a robust earnings surprise history, having posted an average surprise of 2.6% in the trailing four quarters, beating estimates thrice. A thriving water heater industry in the United States, as well as solid consumer product demand in China has been driving the top-line growth of the company over the past few quarters.

However, there are some risks associated with investing in the stock. A.O. Smith operates in a highly competitive market and competes with renowned global brands. Over the past few quarters, A.O. Smith’s SG&A expenses in China (including elevated steel costs and higher fees paid to installers) have been quite high, adding to the company’s overall operating expenses. Higher selling costs to support expansion in Tier 2 and 3 cities, and e-commerce platform in China, along with developmental costs associated with new products, including expansion of the air purification product portfolio, are escalating the company’s operating expenses in China.

Furthermore, transition of the Chinese economy to a consumer driven one has resulted in a significant slowdown that might impact A.O. Smith’s sales in the region. For 2017, A.O. Smith projects to incur a $20-million sales headwind, due to the anticipated depreciation of the Chinese currency. Consequently, we expect margins for the company's rest of the world division — which includes China — to remain weak.

A.O. Smith currently carries a Zacks Rank #4 (Sell), as we believe its short-term risks outweigh the company’s strengths.

Stocks to Consider

Some better-ranked stocks in the same space include Barnes Group Inc. (NYSE:B) , Illinois Tool Works Inc. (NYSE:ITW) and Altra Industrial Motion Corp. (NASDAQ:AIMC) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Barnes Group has a solid earnings surprise history for the trailing four quarters, having beaten estimates each time for an average of 9%.

Illinois Tool Works also has a decent earnings surprise history, with an average beat of 3.3% over the preceding four quarters, beating estimates each time.

Altra Industrial generated four strong beats during the same time frame, for an average positive surprise of 17.3%.

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