Who doesn’t love Adam Savage, and Jamie Hyneman, blowing up things on their show Mythbusters? Alongside Kari Byron, Tory Belleci, and the late Grant Imahara, Mr. Savage and Mr. Hyneman have blown up Toilets, an RV, and a Cement Truck, to name just a few of their bigger explosions. One such impressionable explosion was the Hot Water Heater.
In this video, Mr. Savage and Mr. Hyneman put Hot Water Heater to the test by overworking its systems and increasing pressure beyond its limit. The resulting explosion is a clean exit from the “building” with some cracked cinder block underneath and a structure shaken from its core. Such an explosion, in the words of The Hyneman, “would ruin your house.” Understanding that a Hot Water Heater going rogue and exploding is rare and vital because it wouldn’t be so widespread and in commercial use, if it weren’t.
According to the 2015 Residential Energy Consumption Survey by the U.S. Energy Information Administration, 73.9 million Single-Family Detached Housing Units of the 118.2 Total Housing Units in the United States have a water heater, with 94% not housing a secondary water heater. Roughly 50% of Single-Family Units contained a medium-sized water heater (31 to 49 gallons), with 39% of Single-Family Units operating a large-sized water heater (50 gallons or more). Regarding energy consumption, at an average of 14.8 million British Thermal Units (BTU), the water heater was the second-largest energy consumer in a household, right after Space Heating at an average of 35.3 million BTU. America’s largest home improvement retailer, Home Depot Inc (NYSE: HD), offers a guide on their website, suggesting that the Average Total for New Water Heater Tank and New Tankless Water Heater is $1,500 and $3,500, respectively. Breakthroughs in science and engineering in the late 19th century allowed for the commercialization and mass adoption of the Water Heater in society and to think of once a Milwaukee-based bomb-casing maker as now a Milwaukee-based Aristocrat.
From Bomb-Maker to an Aristocrat and Water Treatment
The company in discussion is A.O. Smith Corporation (NYSE: AOS), a Standard and Poors 500 component headquartered in Milwaukee, Wisconsin, with a market capitalization of $11.56 Billion with approximately 13,900 non-union employees. A.O. Smith manufactures residential and commercial gas, tankless and electric water heaters with operations and revenue generated from U.S. and global markets. Founded in 1874 by Charles Jeremiah Smith, the company has experienced various iterations supporting different arcs of time with manufacturing and deliverables. One such arc would be the early 20th century and its participation in the war effort.
A.O. Smith offers a video that provides an insightful history into the early and formative years. Formerly a bike and steel frame manufacturer, A.O. Smith’s expertise in welding and manufacturing allowed the company to become an essential part of American history. How important? According to the War Memorial Center in Milwaukee, Wisconsin, entry and aiding in World War II meant A.O. Smith matched demand for ten times the size of bombs produced in WW1 at thousand a day. Fast forward to 2021, and the company is not part of any war effort but continues to manufacture Water heaters after exiting the automotive industry in 1997. Year of manufacturing expertise has rendered a trailing 5-year average of $1.7 billion in Total Net Sales between the Fiscal Year 2016-2020 from casing-like structures that help provide hot water in North America alone. In addition, the company operates a Water Treatment business that has been growing in size from $18.4 million in 2016 to $177.2 million in 2020. A granular breakdown of 10-Q statements available at EDGAR suggests that the company generates most of its revenue from the North America division, while the Rest of the World, China specifically at greater than 20%, rendering the rest. The following visual highlights the Percent of North America and the Rest of the World Sales against Total Quarterly Net Sales starting in Q1 2011. The lines represent the respective Percent of Geographic sales, whereas the bars represent Total Quarterly Net Sales (in millions).
A takeaway from the chart is the interaction between the % North America Sales of Total Net Sales and % Rest of the World Sales of Total Net Sales where a decline in the former resulted in an incline in the latter. On average, between Q1 2011 and Q2 2021, North America Sales have increased about 1.72% every quarter compared to 3.82% from the Rest of the World. While the North American segment is their bread and butter, the Rest of the World segment is their growing segment, with Q1 2020 as a key data point reflecting the nuance. In Q1 20, Quarterly Sales in their North America division rose 1.87%, while the Rest of the World fell 52.97% compared to Q4 19. What’s noteworthy is not that the North America division is stalling; the North America division continues to perform with the Water Treatment Products segment adding value to their legacy Water Heater segment.
The following visual breaks down the Quarterly North America Division Net Sales into its respective segments-Water Heater & Related Parts, Boilers & Related Parts, and Water Treatment Products.
A takeaway from the chart is the increase in % of Water Treatment Sales from Q1 17 to Q1 21 with a marginal decline of 53 basis points between Q1 21 and 22. Even though the Water Heater segment generates most North American Quarterly Net Sales, the Water Treatment business shows a growing revenue stream that offers optimism moving forward. Exclusively available at Lowes Companies Inc (NYSE: LOW) for consumers and contractors through A.O. Smith Pro, the AOS line of products include a Whole House and Drinking Water Filtration Systems. Adding on the metric by Fortune Business Insights that the Water Purifier Market is expected to be worth $47 billion in 2028, baked inside an Aristocrat like A.O. Smith is a forward-looking and attractive business.
Stock Performance First Decade vs. Second Decade
Shares of A.O. Smith have returned approximately 9500%, excluding dividends, since it starting trading in 1984. The company has a rich and continued Dividend History dating back to 1983, making it a Standard and Poor’s 500 Dividend Aristocrat. A Standard and Poor Dividend Aristocrat is a company that has “increased dividends every year for the last 25 consecutive years,” and can be tracked using the ProShares S&P 500 Dividend Aristocrats ETF (NOBL). Since October 2013, the Standard and Poors Dividend Aristocrats Index has underperformed shares of A.O. Smith and the broader Standard and Poors 500 Index. The following visual highlights the price performance of shares of A.O. Smith against the Standard and Poors 500 Index and the Standard and Poors Dividend Aristocrats Index. Also included is the Dividend Per Share awarded to shareholders between the period.
While it’s not an apples-to-apples comparison, I would argue that the chart illustrates that the A.O. Smith Dividend has trended better than the Standard and Poors 500 Index and the Standard and Poors Dividend Aristocrats Index line as well, even during periods of share price underperformance. Year to Date (2021) shares of A.O. Smith have performed better than the Standard and Poors 500 Index and the Standard and Poors Dividend Aristocrats Index by approximately 12 and 15 percentage points, respectively. A.O. Smith currently registers a Dividend Yield of 1.43%, which is 14 basis points better than the 10-year Treasury yield of 1.29% as of September 2, 2021.
Since the company has been trading since 2000, I wanted to compare the stock performance of the first decade to the second decade. Between 2000 and 2010, the stock appreciated approximately 190% compared to the almost 670% price performance between 2010 and 2020. Pairing those metrics with a particular interaction between macroeconomic indicators such as the Producer Price Index and New Houses Sold can help explain the differentiated stock price performance and provide insight on looking ahead.
The following visual is from FRED, Federal Reserve Bank of St. Louis, that compares the Percent Change From Year Ago for Producer Price Index of Domestic Water Heater and Total New Houses Sold quarterly starting 2000.
The Black Line represents the Producer Price Index for Domestic Water Heater compared, while the Red Line represents Total New Houses Sold. Careful observation offers a volatile percent change in Domestic Water Heater PPI for the first decade compared to the second. Also visible is a feature where periods of high Domestic Water Heater PPI reflected a low number of New Houses Sold. A hypothesis proposed is that the outperformance in the stock price of A.O. Smith for the period 2010-2020 was partly due to increases in New Houses activity and a relative stasis on prices compared to the opposite for the first decade. However, forecasting the new decade could be tricky since inflation and commodity prices pressures can deliver volatile prices and demand.
In an environment where the 10-year bond is lower than the Standard and Poors 500 IndexDividend Yield(1.29% vs. 1.33%) and the 30-year bond is lower than the Standard and Poors Dividend Aristocrats IndexDividend Yield (1.92% vs. 2.32%), shares of A.O. Smith with a Dividend Yield at 1.41% offer a proposition better than the current 10-year yield. Furthermore, within the Building Products Industry Complex, where the Industry Dividend Yield is 1.11%, A.O. Smithregisters a dividend yield that is 30 basis points better. While stocks are forward-looking and the metrics discussed in this essay are historical, this particular Standard and Poors 500 Index component was worth highlighting its performance and reliability. With almost 60% of U.S households and 20% of Annual Fuel Use, the Water Heater is a piece of technology quintessential to home and A.O. Smith, a market share leader in Residential and Commerical Water Heaters.