A.O. Smith: Go with the Flow

07/31/2015 7:00 am EST

Focus: STOCKS

Tyler Laundon

Editor, Cabot Small-Cap Confidential

If pressed to single out the greatest challenge faced by mankind, I expect most people would cite something related to water, suggests Tyler Laundon, editor of Top Stock Insights.

So where should growth investors look to participate in the world's ever-present need for water?

For pure-play water-related exposure, I like industrial manufacturing firms, the makers of pipes, pumps, filters, purifiers, water heaters, boilers, fans, and so on.

In both developed and developing economies these companies provide much of the equipment that pulls, pushes, pumps, heats, cools, filters, and monitors water.
  
I've looked at a lot of companies that make water-related equipment. And one of my favorite growth-oriented companies is A.O. Smith (AOS).

The firm makes water heaters, boilers, water filtration equipment, solar water heaters, and various other related parts.

A.O. Smith's primary markets are North America (68% of sales), China and India (29.1% of sales), and Europe and the Middle East (2.9% of sales).

Over the last ten years it has made strategic divestments and acquisitions to focus 100% of its energy on water-related products. This has transformed A.O. Smith into a leaner and meaner pure-play water business.

The relatively young water filtration business, primarily focused on reverse-osmosis (RO) filters, has huge promise and should be a huge driver of A.O. Smith's growth over the next decade.  

North America pays the bills and generates cash flow to fund dividends to investors. It's a solid area of business.

But the more exciting growth prospects are in China and India, which now represent 30% of total sales and have been growing at an average annual rate of 28% for the last decade.

The bottom line? A.O. Smith represents a way for growth-oriented investors to get into a pure-play water stock that has a stable business right now in energy efficient water heaters and condensing boilers.

These products are likely to continue to sell well as the North American housing and construction industry grows and as regulations, energy efficiency, and wear-and-tear support replacement sales improve.

And in developing economies, especially China and India, where consumer incomes are growing, A.O. Smith is building a market-leading water equipment business.

Add in the relatively new Reverse Osmosis water filtration business and we have a very solid way to play global demand for clean water and water-related equipment.

The company just beat on both revenue and EPS when it reported fiscal second quarter results late. Revenue of $653.5 million was up by 9.8% and beat by $26 million, while EPS of $0.79 beat by $0.13.   

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