A.O. Smith Has China Fever

China’s economic growth in the second quarter slowed to 7.6%, marking the first quarter to come in below 8% since 2009. One company that’s not feeling the contraction is A.O. Smith (NYSE:AOS), a world leader in the manufacture of water heaters.

It announced second-quarter earnings on July 18, and China was a big reason for delivering excellent results. The stock jumped 6% on the news and is trading around $51, near a 52-week high. I look for it to continue to outperform the markets as its moves into China and India pay further dividends.

A.O. Smith is hardly an overnight sensation in China. It’s taken 17 years to build the infrastructure necessary to capture 20%-plus residential market share. Its closest competitor is Haier, a Chinese conglomerate, with 18%.

How did A.O. Smith achieve such success against a Chinese domestic rival? In 1995 Smith entered into a joint venture with a Chinese partner, and three years later bought out its partner and opened a manufacturing plant in Nanjing. In 2012, it’s opening a second plant.

On the distribution front, it’s helped distributors open 1,000 A.O. Smith Stores through the end of 2011, and it plans to open 200 in each of the next three years. By 2014, its products will be sold in 7,600 stores across China. It’s this kind of on-the-ground attention to detail that’s allowed Smith to pump up sales by 25% annually over the past nine years.

What it’s already done in China, it now plans to do in India.

Smith opened a 76,000 square foot plant in Bangalore in 2010, and it’s slowly building the brand. Its 2011 revenues in India were $18.1 million, more than double those in 2010. Now compare this with China, where last year’s revenues were $371.7 million. India’s only at the beginning of its growth curve, while Smith’s Chinese business is far more mature.

Regardless of what happens in North America, which is doing just fine, China and India will continue to represent a more important part of Smith’s overall business. At present, the two countries account for 24% of sales. Once India ramps up, I could see that easily doubling within five or six years. The world is its oyster.

What makes A.O. Smith special isn’t that it’s growing in China and India. Many American companies are doing the exact same thing. It’s how Smith is doing it that’s so special.

Recently, The Wall Street Journal reported that 14% of U.S. companies surveyed by an MIT professor are planning to bring some manufacturing back home. That’s good news for American jobs. General Electric (NYSE:GE), one of Smith’s competitors, is among those companies.

But none of this affects Smith because it already manufactures many of its products in North America. In 2011, 35%, or $599 million of its total net sales of $1.7 billion, came from products manufactured and sold outside the U.S., mainly China.

However, its 2011 10-K indicates its rest-of-the-world sales came to $456 million, leaving a $143 million difference. The solution to this mathematical mystery: The $143 million most likely represents products sold in Canada and made in Canada.

Why is this important? Because it highlights the beauty of its business model. A majority of its products, if not all, sold in North America are made in North America. The same holds true for China and India.

This is the way globalization is supposed to work. Forget shipping product from China to North America and vice versa. Make the product where you’re going to sell it. Your costs will be lower, and you’ll build stronger markets. These guys are doing it the right way. On this alone, I’d own its stock.

An analyst at Keybanc just downgraded Smith based on its current valuation and 24% gain year-to-date. Forget Keybanc’s advice. Warren Buffett likes to buy great companies at fair prices. A.O. Smith’s business model proves it’s a great company, and by almost every valuation metric, it’s trading for less than GE even though it’s growing much faster.

This is a company to own forever.

As of this writing, Will Ashworth did not own a position in any of the stocks named here. 

Article printed from InvestorPlace Media, https://investorplace.com/2012/07/a-o-smith-has-china-fever/.

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