A.O. Smith Corporation (AOS), began as a family-operated machine shop in Milwaukee in 1874 and was originally known as a bicycle parts manufacturer. The company came into the spotlight when it created the world’s first pressed steel car frame. It soon made a name for itself as one of North America’s largest manufacturers of steel automobile frames. In 1936, the company patented the glass-lined water heater that eventually become an industry standard, and the company expanded to Europe during the 1970s.

Smith underwent a dramatic transformation starting in 1997, when it decided to sell to Tower Automotive its auto parts division, which was responsible for making the company one of the largest independent producers of car and truck frames. This decision was largely based on the changing nature of the auto industry, which was beginning to require suppliers to make significant investments in new products and overseas operations. Instead of keeping up with the trend, AOS decided to focus its attention on its nonautomotive segments, which were essentially engaged in manufacturing water heaters and electric motors. The decision to focus its resources on markets where it had higher margins was a good move.

The company has continued to grow primarily through acquisitions, by acquiring manufacturers of water heaters and boilers. In 1995, it entered the market in China, which has enhanced its international presence and added significantly to the top line. Additionally, in 2008, A.O. Smith started to do business in India, which has yet to prove as successful as the operations in China. The latter comprises the bulk of foreign operations, where an expanding market and market-share gains in both the water heating and water treatment business are proving to be a growth engine. To further strengthen its position in water technology, Smith has continued to invest in innovation, complementing its product lines with features and enhancements that benefit customers, and building up its brand name through advertising.

Over the last couple of years, earnings growth has outpaced revenue gains. Moreover share repurchases have helped increase share earnings. Acquisitions remain an active part of A.O. Smith’s strategy and should support the company’s intention to become a universal leader in water technology. Hence, investors should expect further acquisitions, domestically and internationally, in this space. Of note, it acquired Lochinvar Corporation in 2011. Lochinvar is a well-known   manufacturer of higher-end, good-efficiency commercial and residential boilers.

We are optimistic about the company’s performance over the next few years as an improving economy, along with positive performance in Asia, should support revenue growth and earnings momentum. The key risks that stand out are volatility related to steel prices, which will cause volatility in raw materials, and the possibility of a sudden economic slowdown in China, currently one of its key markets. The inability to integrate likely acquisitions in the future is also a possible risk.

A.O.Smith’s gains in recent years have largely been the outcome of its efforts to focus on its water heating business and shed its noncore businesses.  Additionally, its strategy of selling to large developing markets has helped to offset a weaker domestic market during difficult times.

For a more detailed analysis of the company’s prospects, as well as the particular investment merits of the stock, subscribers can peruse our full report in the The Value Line Investment Survey.   

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.