A. O. Smith (AOS) is Restructuring Water Treatment. Can It Earn Better Returns Beyond Water Heaters?

A. O. Smith Corporation (NYSE:AOS) has a dependable replacement water-heater business. The harder question is whether its distribution relationships and brand strength can produce attractive returns in water treatment. Softer residential demand and higher steel costs are testing that expansion while weakness in China weighs on group earnings.

A. O. Smith Corporation trades at 13x forward earnings, versus 15x trailing earnings. The forward figure uses 2027 adjusted estimates; trailing earnings include restructuring charges. Analysts expect about 9% adjusted EPS growth in 2027 after a weaker 2026. The gap therefore combines recovery expectations with accounting exclusions.

For A. O. Smith Corporation, that valuation looks reasonable if restructuring improves recurring returns. Comparable 2027 forward multiples are 25x for Watts Water Technologies, Inc. (NYSE:WTS) and 10x for Pentair plc (NYSE:PNR). Management guides to $3.70–$3.85 in 2026 adjusted EPS versus $3.85 in 2025, implying a 2% midpoint decline, against consensus growth of 20% at the higher-valued peer. Consensus 2027 growth is closer, at roughly 9%, 11% and 12%, respectively. China and margin-recovery risks help explain the discount to the higher-valued peer; the cheaper peer’s pool-equipment exposure limits comparability.

Distribution Must Produce Better Margins

A. O. Smith Corporation benefits when a failed water heater needs prompt replacement. Plumbers value product availability, and established wholesale relationships support repeat orders. Water-treatment products share some channels, but also require specialist dealers and consumer marketing. The investment test is whether distribution produces profits that survive higher fulfillment and input costs.

Second-quarter North American sales rose 5%, or 3% excluding an acquisition. Boiler growth and pricing helped, while residential water-heater volumes weakened. Yet A. O. Smith Corporation reported an adjusted regional margin of 24.4%, down from 25.4%. The first quarter also showed margin compression. Steel inflation and weaker unit demand are absorbing revenue gains before they reach shareholders.

A. O. Smith Corporation booked a $22.6 million water-treatment restructuring charge to simplify its manufacturing footprint and brands. Management targets $6 million–$8 million in annual savings beginning in 2027. The charge includes $12.4 million of noncash impairments, so dividing the headline charge by savings would misstate cash payback. Success requires savings that exceed transition costs without weakening service or customer retention.

Regional margins combine water heaters, boilers, and treatment. A recovery would support the thesis, but stronger heater profits alone would not demonstrate that treatment earns attractive returns. Fewer facilities must translate into lower recurring costs while retaining profitable sales.

Cash Gains Must Outlast Working-Capital Benefits

A. O. Smith Corporation generated $253.8 million of operating cash in the first half, up from $178.3 million. After capital expenditure, free cash flow was $233.3 million. Working capital absorbed less cash than a year earlier, and lower capital spending also helped. Those improvements strengthen liquidity, but they can coexist with weaker underlying earnings.

Financing also matters. June debt totaled $637.5 million against $181.3 million of cash following the January acquisition. First-half interest expense roughly doubled to $15.2 million. Dividends and repurchases totaled about $262 million, exceeding free cash flow. Investors should consider the financing cost of improving earnings per share alongside the benefit of a smaller share count.

For A. O. Smith Corporation, China presents another obstacle. Second-quarter local-currency sales there fell 28%, while the broader international segment’s margin dropped to 5.2% from 10.5%. Less factory throughput spreads fixed costs across fewer sales. North American savings cannot establish a durable group recovery while international profitability keeps eroding.

Conclusion

A. O. Smith Corporation looks fairly valued at 13x forward earnings. Replacement demand supports the franchise, but the multiple already uses a recovery-year earnings estimate. Recurring treatment savings, stronger North American margins, and stabilizing international profits would justify a more positive judgment. Continued margin deterioration, or cash distributions persistently exceeding internally generated cash, would weaken the case despite the discount to the higher-growth peer.

While we acknowledge the risk and potential of AOS as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than AOS and that has 10,000% upside potential, check out our report about this cheapest AI stock.

READ NEXT: SPX Technologies (SPXC) Buys FIS Water for $410M. Can Water Management Lift Cooling Returns? and Crane Company (CR) Plans a $240M Pump Deal. Can Aftermarket Earnings Justify the Price?

This article is originally published at Insider Monkey.