$48.28
$94.47
bear $48.28
base $69.76
bull $94.47
margin of safety $45.00
market price* $59.22
A. O. Smith makes water heaters, boilers and water treatment products. North America (United States and Canada) produced $2,984M of 2025 sales and $728M of segment earnings at a 24.4% margin; Rest of World, mostly China plus India, produced $880M of sales but only $76M of earnings. Roughly nine-tenths of the profit therefore comes from a North American business that is driven mainly by replacement of failed water heaters in a large installed base, where A. O. Smith, Lochinvar and its other brands hold leading positions and have passed through steel and tariff costs with regular price increases. Earnings power. We measure the cash the business produces for its owners: operating cash flow, less swings in working capital, less stock compensation, less the capital spending needed to maintain the business. On that basis owner earnings rose from $306M in 2016 to $570M in 2025, and were $505M, $497M, $576M, $505M and $570M over 2021-2025. Interest is small (about $4-14M a year), so cash flow before lenders over 2021-2025 has a median of about $511M. We use that five-year median, which reflects today's price levels and product line, rather than the strong 2025 year. Two changes since then push in opposite directions: China has deteriorated sharply (third-party China sales fell 28% in local currency in the second quarter of 2026 and the Rest of World margin dropped to 5.2%, so that segment now earns perhaps $40M a year instead of $76M), while the January 2026 purchase of Leonard Valve for $470M adds roughly $70M of sales and about $20M of pre-tax earnings. These roughly offset, so we start from about $510M a year, or about $3.70 per share on 138M diluted shares. A 2022 pension settlement charge of $417M and a 2017 tax-reform charge of $82M were non-cash and do not reduce these figures. Amortization of acquired intangibles is small (about $15M a year) and relates mostly to durable brands. Growth. Owner earnings grew 12.9% in 2025, but 2026 is running weaker: management expects residential water heater volumes to fall at a low-double-digit rate, steel costs were up about 20% in the second quarter, and the company booked $22.6M of restructuring and impairment charges for its North American water treatment business. We therefore assume no growth in the first year. After that, the base case credits 2.5% a year: revenue has been flat from 2023 to 2025 at about $3.82-3.85B, and growth from 2018 to 2025 was under 4% a year including acquisitions, so we stay below that record and credit only the long-demonstrated ability to pass costs through in price. Expected heat-pump demand from the 2029 federal efficiency standard, new boiler products and a China recovery are not credited because none is in hand. After year ten we hold earnings flat rather than assume growth: the need to replace tens of millions of installed water heaters and boilers is structural and has sustained this franchise for decades, but we credit nothing beyond keeping that position. Debt. At June 30, 2026 the company owed $637.5M, mostly a term loan taken on for Leonard Valve that matures in January 2029, against $181.3M of cash, for net debt of about $456M (about $3.30 per share). Debt is roughly 1x a year of cash flow and interest costs are near our 6% rate, so no refinancing stress is built into any case. Bear case ($48 per share): China contributes nothing and the company exits it at a one-time cash cost of about $50M; North American margins fall from 24% back toward 21% as the residential volume decline, steel inflation and tariffs outpace pricing. Cash flow before lenders drops to about $410M, falls 2% the next year, then grows only 1% a year. The business is worth about $7.1B, less $456M of net debt, leaving about $6.7B for shareholders. Base case ($70 per share): North America holds its margins, China stays at its reduced level, Leonard Valve performs as acquired. Cash flow starts at $510M, flat for a year, then grows 2.5% a year to about $637M in year ten and holds there. The business is worth about $10.1B, less $456M of net debt, leaving about $9.6B. Bull case ($94 per share): the 2026 price increases of 4-7% stick, boilers keep growing (up 12% in the first half of 2026), China stabilizes near its 2025 level, and the company keeps making tuck-in acquisitions as it has for 15 years. Cash flow starts at $535M and grows 2% then 4% a year, with 1% a year afterward reflecting continued pricing power. The business is worth about $13.5B, less $456M, leaving about $13.0B. Since our previous analysis in August 2026 (bear $35, base $66, bull $96), the cases have narrowed. We now value every company at the same 6% rate and express risk only through specific events in each case, which raises the bear case; we have also added the Leonard Valve earnings together with the debt used to acquire it, and lowered the bull case's long-run assumptions. The outcome of the China strategic review, which management said would conclude by its next earnings report, is not yet known; a divestiture or partnership could leave more value than our bear case assumes. Margin-of-safety price ($45). The bear case at about $48 is a reasonable floor for a business with durable cash flow and modest debt, while the base case near $70 is the likely value. The margin-of-safety price of $45 sits below the bear case's value, and from that price the base case implies about 20% a year over about three years if the shares move toward it, with the dividend of about $1.40 a share a year counting toward that return. What would make this wrong: a lasting share loss in North American water heaters, for example during the 2029 shift to heat-pump models, or margins that fail to recover from steel and tariff costs.