Summary
- Hot water heater maker A. O. Smith has underperformed the S&P 500 dramatically in recent years.
- Despite that, it has delivered reasonably strong business results and has continued to increase its dividend.
- Short sellers suggest that the company's current problems in China will destroy the company's long-term outlook.
- I disagree and see this as a good time to buy on weakness while most other industrial stocks are surging.
- Looking for a helping hand in the market? Members of Ian's Insider Corner get exclusive ideas and guidance to navigate any climate. Get started today »
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A. O. Smith (AOS) is a long-running American industrial firm. It's been in business for more than 80 years and primarily distributes and sells hot water tanks and boilers. Like with many Dividend Aristocrats - companies that have hiked their payouts for 25 or more consecutive years - A. O. Smith has managed to make consistently increasing profits out of a far from glamorous business.
Until a couple of years ago, AOS stock was a superstar, handily crushing the market and delivering jaw-dropping returns:
Source: YCharts
A buyer of AOS stock 20 years ago would now be up 1,750%, compared to a 217% gain for the S&P 500 over the same span. As you can see from the chart, while the company has outperformed consistently, its gains really started to sizzle after the Financial Crisis. This is, it appears because the company started to have major success in overseas markets with a huge business emerging in China in particular.
Alas, that strength has now turned to weakness. As you can see, the rise in AOS stock suddenly ended about two years ago, and now it's caught in the midst of a serious correction, even as the stock market as a whole pushes to fresh new highs. Is the slowdown in A. O. Smith a temporary event, or the end of a phenomenal run? The bears argue that A. O. Smith's outperformance is over, and shares have farther to fall.
Short Sellers Pound A. O. Smith
In May, China-focused research firm J Capital published a report on A. O. Smith alleging accounting shenanigans and questionable transactions, among a long list of things. It turns out that Spruce Point, another short selling firm, had also been doing research into AOS stock as well, and that firm piled on with a Twitter spree taking shots at the company as well. For example:
Source
The short sellers made a number of allegations regarding A. O. Smith's Chinese business including that it had misleading relationships with its Chinese affiliates, couldn't access all its cash there, and that its margins are slumping, among others.
AOS stock slid as much as 10% immediately following the J Capital report and got hit for a nearly 30% peak-to-trough decline around those negative publications:
Source: YCharts
I purchased AOS stock at $44 after reading the bearish analyses and doing my own research. As I wrote to Ian's Insider Corner members at the time:
As is sometimes the case with these bearish reports, the first few pages look alarming, with lots of talk of hidden distributors, missing cash, accounting fraud, and so on. Read on though, and it ends up turning to thin gruel pretty fast.With a good solid short report, it should be easy to explain where the fraud is and how it occurred. The AOS short thesis doesn't have this component. It's complicated, relies on a lot of circumstantial connections, and requires some leaps of logic which assume the worst rather than other equally plausible more innocuous explanations.
As I noted at the time, the short reports were, in a way reassuring, in that they confirmed that A. O. Smith's China business is real, large, and relatively profitable even if things perhaps aren't quite as good as management projects.
...Originally Posted On Seeking Alpha
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