A.O. Smith Checks Every Box Possible in Its Recent Earnings

By Tyler CroweMarketsFool.com

Few things give investors that warm, fuzzy feeling like seeing a company have everything go right in a quarter. For A.O. Smith (NYSE: AOS) investors, that was this past quarter as the market for its products and management's handling of the situation all swung in the company's favor.

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Let's take a look at the company's most recent quarterly results to see how well the quarter went for the water and air treatment equipment manufacturer, management's outlook for the rest of the year, and how investors should view this stock today.

Image source: Getty Images.

By the numbers

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*in millions, except per-share data. Source: A.O. Smith earnings release.

If you are looking for a company where everything went right in the quarter, then A.O. Smith is where you should look. Revenue and earnings were both up quarter over quarter by double digits, and every aspect of the business produced stronger than expected results.

In North America, sales were up 15% to $487 million on both higher volumes sales and a price increase that took place in August of 2016 of offset rising steel prices and overall cost inflation. It should also be noted that part of that sales increase was from the August acquisition of the Aquasana water treatment business. That added about $10 million to that sales figure. If we really wanted to nitpick the company's results, operating margins for North America slipped 30 basis points to 21.4%, which was mostly related to the Aquasana acquisition.

Outside of North America continuesto be the real growth engine for the company. Sales for the rest of the world increased 19% to $260 million. Much of that gain was a result of China sales growing 27% (20% when adjusted to U.S. dollars). The company has really found an interesting niche with water treatment and air purification equipment, which grew sales 50% and 80%, respectively. Even more encouraging, though, is that rapid sales growth hasn't deeply impacted costs as margins for this business segmentwere more or less flat at 12.5%.

As is common with manufacturingcompanies, there are periods of working capital builds that eat into operational cash flow. This was one of those periods for A.O. Smith as operations actually burned through $11.5 million before capital expenditures. This shouldn't be too much of a concern, though, as the company went through a similar working capital build this time last year, but ended up generating $365 million in free cash flow for the fiscal year. Also, the company still has plenty of cash on its balance sheet that enabled it to buy back a little more than 600,000 shares. Management still has the authority to buy another 4.3 million shares under its existing share repurchase program.

From the mouth of management

CEOAjita G. Rajendra seems pretty confident in the company's outlook for the year. As part of his press release, he announced that management was upping its earnings guidance for the year.

What a Fool believes

I'm not sure you can ask much more from this company. Sales continue to grow at surprisingly robust rates for products like water heaters and air purification systems. Certainly, in the U.S. these are mature markets that mostly focus on replacements rather than new home starts. Having made inroads into China -- and doing the same in India today -- should give the company a decent growth runway as those two countries bring huge populations into the middle class. On top of that, the company has been able to achieve this all while maintaining high rates of returns for investors over the long term.

AOS Return on Invested Capital (TTM) data by YCharts.

With shares trading at 27 times earnings -- well above its historical average -- there is a question as to whether investors are paying too much for this stock today. Based on the company's results and outlook for the year, I don't think anyone will be completely disappointed with A.O. Smith's stock, but those returns are starting to diminish at that price.

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Tyler Crowe has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.