The US business of the boiler manufacturer AO Smith is the core of the company and accounts for around two-thirds of its sales. This is a slow-growth company, with replacements and new construction representing an annual revenue growth of 4%. The rest of the business, however, lies in fast-growing markets such as China and India, where annual sales growth of around 14% is expected. The combination of a slow but solid core business and a rapidly expanding emerging market business has led to annual earnings growth of 26% since 2010.
The dividend yield is currently 1.3%, which seems rather low. But that’s actually the highest yield in about five years. Meanwhile, the payout ratio is a modest 33% and has been below 30% for the past ten years in all except one calendar year. Long-term debt is only about 15% of the capital structure, a very modest level. So there is little reason to fear a dividend cut here.
But there are two more factors to consider. First, a slowdown in China, the company’s biggest overseas market, has sparked concerns among some investors that growth will slow. Management thinks these concerns are exaggerated. In addition, India is a relatively new market for AO Smith, where it should make up for lost ground in China. The sell-off, which has pushed the yield to a five-year high, could be a buying opportunity for those with a long-term focus.
Second, the relatively low return is offset by the company’s massive dividend growth, which has been 17% annualized over the last ten years. The dividend has meanwhile been raised for 25 consecutive years.
Basically, AO Smith could add a small income growth to a portfolio that focuses more on high yield. This growth would then come from a company with a solid dividend and an impressive dividend history.
