This Company Can Escape the Chinese Real Estate Crisis

Water heater company, A.O. Smith (AOS 1.49%), reported positive second-quarter earnings last week. Management reaffirmed its 2022 full-year guidance, but its geographical markets, including China, showed vastly different results. Let’s take a closer look.

All over the map

Last week, AO Smith reported encouraging financial results for Q2 2022. Sales jumped 12% over last year to $966 million. Adjusted earnings per share (EPS) increased 14% to $0.82. AO Smith breaks out its results by geography. Sales in North America popped 23% in Q2 to $744 million, and adjusted earnings in the region came in at $163 million. As a show of AO Smith’s brand power, price increases added $109 million to operating earnings in the region. The price increases far outpaced the company’s $85 million in additional inflationary costs.

In its “rest of the world” region, sales slumped 13% to $230 million and adjusted earnings to $18 million. The poor results were based on COVID-related lockdowns in AO Smith’s largest international market, China. However, sales began to increase in China after lockdown restrictions ended during the quarter. Sales in India ballooned 79% in the quarter, though the market is a small territory for AO Smith.

Image source: Getty Images.

AO Smith management was encouraged enough by Q2 results to issue guidance that painted an optimistic picture for the remainder of 2022. They expect adjusted EPS to finish the year between $3.35 and $3.55. At the midpoint, EPS would show a 16.5% improvement over the $2.96 in EPS that AO Smith generated in 2021. In addition, the guidance forecasted revenue would increase 12% to 14%, and the company would use most of its estimated $450 million to. $500 million in free cash flow to repurchase $400 million in company shares.

Is AO Smith a buy right now?

Admittedly, selling water heaters is not an exciting business, but it is a high-quality one. For instance, what does someone do if they are blasted with cold water during a shower? Most likely, they call the local plumber or landlord. Having reliable hot water is essential to everyday living, and AO Smith has benefited handsomely over the years. Due to those chilling blasts, 80% to 85% of AO Smith’s sales are replacements, which provide the company with a growing quasi-recurring revenue stream.

One concern that investors may have is AO Smith’s Chinese exposure. China’s real estate market is going through a major crisis. Property sales in China are on pace to fall more than during the 2008 global financial crisis. About 26% of AO Smith’s sales in 2021 came from China. Much of that revenue may be replacement sales, which could withstand a real estate market crash, but new water heater sales could be at risk. To put investors at ease, AO Smith had $459 million in cash at the end of the quarter. Even after subtracting debt, the balance sheet is left with $161 million of net cash.

Over the last month, AO Smith shares have jumped 11%, but they’re down just over 7% for the year. The shares have outperformed the market for the year and month. The outperformance could be attributed to the necessary products the company makes. Though the shares are down modestly, they trade at a forward price-to-earnings (P/E) multiple of about 23 times, which is in line with its five-year average. At this point, investors may be getting a fair price for AO Smith stock, which may prove resilient in a potential crisis in Chinese real estate.

BJ Cook has no position in any of the stocks mentioned. The Motley Fool recommends AO Smith. The Motley Fool has a disclosure policy.

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