A. O. Smith Corporation operates through two segments: North America and Rest of World. The Company's Rest of World segment primarily consists of China, Europe and India. Both segments manufacture and market comprehensive lines of residential and commercial gas, gas tankless and electric water heaters, as well as water treatment products. Both segments primarily manufacture and market in their respective regions of the world. Its North America segment manufactures and globally markets specialty commercial water heating equipment, condensing and non-condensing boilers and water systems tanks. It also manufactures and markets in-home air purification products in China. It serves residential and commercial end markets in North America with a range of products, which include water heaters, boilers and other. It supplies water heaters to the residential market in China with a broad product offering, including electric, gas, gas tankless, heat pump and solar units, as well as combi boilers.
FINANCIAL RATIOS of A.O. Smith (AOS)
|Price to Sales||3.8|
|Price to Book||6.8|
|Price to Tangible Book|
|Price to Cash Flow||23.1|
|Price to Free Cash Flow||28.2|
|Sales Growth Rate||5.9%|
|Sales - 3 Yr. Growth Rate||%|
|EPS Growth Rate||%|
|EPS - 3 Yr. Growth Rate||%|
|Capital Spending Gr. Rate||11%|
|Cap. Spend. - 3 Yr. Gr. Rate||-3.7%|
|LT Debt to Equity||20.9%|
|Total Debt to Equity||21.4%|
|Return On Assets||12%|
|Ret/ On Assets - 3 Yr. Avg.||10.6%|
|Return On Total Capital||18.5%|
|Ret/ On T. Cap. - 3 Yr. Avg.||16.3%|
|Return On Equity||22.1%|
|Return On Equity - 3 Yr. Avg.||19.2%|
|Gross Margin - 3 Yr. Avg.||39.3%|
|EBITDA Margin - 3 Yr. Avg.||17.8%|
|Oper. Margin - 3 Yr. Avg.||15.1%|
|Pre-Tax Margin - 3 Yr. Avg.||15.1%|
|Net Profit Margin||12.2%|
|Net Profit Margin - 3 Yr. Avg.||10.7%|
|Effective Tax Rate||29.4%|
|Eff/ Tax Rate - 3 Yr. Avg.||28.9%|
AOS stock valuation input parameters
Revenue. Company's revenue (or sales) is always the starting point of any cash flow forecast. In the AOS stock intrinsic value calculation we used $2997 million for the last fiscal year's total revenue generated by A.O. Smith. The default revenue input number comes from 2017 income statement of A.O. Smith. You may change it if you feel that it should be adjusted for some unusual circumstances that are not expected to be repeated in the future or if you already know (from interim financial statements, for example) that this year's revenue is going to be quite different.
Revenue growth rate. Forecasted future revenue growth rate is the most important input parameter for the intrinsic value calculation. Unlike other input parameters that are reasonably expected to be in line with their historic averages or their historic trends, the revenue growth rate by and large is a wild card: nobody really knows what the company's revenue will be in the future. Of course, the level of unpredictability is different for different industries (utility companies being the most predictable and, thus, less risky).
We use three input parameters to forecast the revenue growth rate in our AOS stock valuation model: a) initial revenue growth rate of 11.6% whose default value is the revenue growth rate in the most recent quarter compared to the quarterly revenue a year ago; b) terminal revenue growth rate of 5% whose default value is chosen to be close to the average nominal (i.e. not adjusted for inflation) GDP growth rate; and c) revenue decline factor of 0.9, which stipulates that revenue growth rate in each forecasted year will be equal to the difference of the revenue growth rate in the preceding year and the terminal revenue growth rate multiplied by this revenue decline factor (with the passage of time the revenue growth rate will be approaching the terminal revenue growth rate, but not quite reaching it - though the difference could be infinitesimally small).
At the revenue decline factor of 1, the future revenue growth rate is forecasted to be constant and equal to the initial revenue growth rate. The smaller the revenue decline factor, the faster the revenue growth rate will approach the terminal revenue growth.
Discount rate. The discount rate is used for determining the present value of future cash flows: future cash flows are "discounted" as at normal conditions (that translate into positive expected return on investment) one dollar today is worth more than the same dollar in the future. Unlike all other valuation models, we use variable discount rate, i.e. it increases for each consecutive year. This is done to account for higher risk of cash flows coming in further in the future.
The initial discount rate of 4.3%, whose default value for AOS is calculated based on our internal credit rating of A.O. Smith, is applied to the cash flow expected to be received a year from now (well, actually, to be precise, in the financial year following the base year - the last year for which we have financial statements). For each consecutive year the discount rate is multiplied by the discount rate multiplier of 1.05, e.i. each year it increases by 5%. Feel free to change this number to correspond to your level of risk assessment of A.O. Smith.
By the way, it is easy to set the discount rate to be constant (this would make comparison with other valuation models easier): just set the discount rate multiplier equal to 1 and chose the magnitude of the initial discount rate to your liking.
Variable cost ratio is the ratio of variable costs (i.e. costs that fluctuate with fluctuation of the volume of production) to the revenue expressed as a percentage. In the calculation of intrinsic value of AOS stock the variable cost ratio is equal to 80.7%.
Fixed operating expenses is just that - expenses that are not dependant on the volume of production. They are set to $60 million in the base year in the intrinsic value calculation for AOS stock. These expenses increase with the level of inflation in subsequent years.
Interest rate on debt is the average all-in rate of interest paid by the company on its debt. It is set at 5.4% for A.O. Smith.
Corporate tax rate of 27% is the nominal tax rate for A.O. Smith. In reality, companies find ways to pay much less taxes than that or not to pay them at all.
Cash flow adjustment could be used for any adjustment the investor deems necessary. Most commonly we use this field to account for stock options-related effects in excess of what is reported on the company's income statement. The cash flow adjustment is expressed as a percentage of the revenue, and in the current valuation of the AOS stock is equal to 0.3%.
Production assets are the company's assets used for manufacturing products or provision of services. In the valuation model input table they are expressed as a percentage of revenue and for AOS are equal to 43.6%.
Life of production assets of 10 years is the average useful life of capital assets used in A.O. Smith operations. It is used to calculate yearly capital expenditures needed to keep these assets in good order - we call it the maintenance CAPEX.
Working capital is the difference between the company's current assets and liabilities. In the model we use the ratio of working capital to revenue, which for AOS is equal to -8.1%. A negative number means that the company is apt at using financial resources of its suppliers and customers; a large positive number, on the other hand, means that it either provides in-kind financing to others or is not good at managing its inventories.
Book value of equity - $1649 million for A.O. Smith - is used in calculation of the "floor" for intrinsic valuation based on the discounted cash flow (DCF) method. Even if the prospects are very bad for a company, its assets could always be sold now for their current fair market value.
Shares outstanding of 172 million for A.O. Smith is needed to calculate the intrinsic value of one share.
Market capitalization is used here only for reference purposes and as a quick check that the share price and the number of shares outstanding numbers are correct - something especially to be cognizant about at stock splits. So, the market capitalization of A.O. Smith at the current share price and the inputted number of shares is $10.2 billion.