Water is one of the most vital components of life, asserts Bob Ciura; in this special 5-part report, the editor of Sure Dividend concludes his review his current top recommendations in the water sector.
In general, water stocks have simple business models and are resilient to recessions thanks to the essential nature of their business. This article will discuss a top water stock, A.O. Smith (AOS).
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A.O. Smith is a leading manufacturer of residential and commercial water heaters, boilers and water treatment products. A.O. Smith generates two-thirds of its sales in North America, and most of the rest in China, with a small amount across the rest of the world. The company has raised its dividend for 28 years in a row, making the company a Dividend Aristocrat.
The company has performed well in 2022, as it continues to generate growth even in a difficult economic backdrop. On July 28th, the company reported second-quarter financial results. Revenue of $966 million rose 12% year-over-year, and beat analyst estimates by $6 million. Meanwhile, adjusted earnings-per-share of $0.82 beat expectations by $0.01 per share, and increased 11%.
A.O. Smith has also reaffirmed its guidance for 2022. The company is forecasting earnings-per-share in a range of $3.35 and $3.55. At the midpoint of the guidance range, A.O. Smith’s earnings-per-share would rise by 14% compared to 2021.
A.O. Smith has grown its earnings-per-share by 20% annually since 2009, which is a very attractive growth rate. The company’s profits grew relatively consistently during that time frame. There are two major catalysts for the company’s future growth: the strong U.S. housing market and projected growth in the emerging markets, specifically China, where sales have grown by ~20% per year on average during the last decade.
China’s huge population, its robust GDP growth, and the booming of its middle class are major tailwinds in this important market. In addition, thanks to the severe pollution of the country, the demand for air purifiers should remain strong as well.
Dividend Safety & Expected Returns
A.O. Smith currently pays an annualized dividend of $1.12 per share, which provides a 1.8% dividend yield. This is slightly above the S&P 500 average yield of 1.6%. We also expect 6% annual earnings-per-share growth, which will add to shareholder returns.
Lastly, the stock appears undervalued. Based on the midpoint of 2022 guidance, AOS stock trades for a P/E of 17.5, compared with our fair value estimate of 19. Total returns are estimated at 9.0% per year over the next five years.
Importantly, the company has a secure dividend. Although it is not immune from economic downturns, A.O. Smith has remained steadily profitable, even during recessions.
The forecasted dividend payout ratio of 33% leaves plenty of room for continued dividend increases, especially as the company’s earnings should continue to rise. It also allows for high dividend growth. Over the last five years the company’s average dividend growth rate is at a high level of more than 20%.
