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A.O. Smith (AOS), a manufacturer of water heaters and boilers, is feeling a chill today as shares sink sharply lower after the company issued downside Q3 EPS and revenue guidance while also cutting its FY24 outlook. Since AOS reported mixed Q2 results in late July, business conditions have materially deteriorated, especially in China, where sales are estimated to have fallen by 17% due to lower volumes of its core water heating and water treatment products.

• In that Q2 earnings report, AOS reaffirmed its FY24 sales guidance of an increase of 3-5% in the wake of the company generating record sales of $1.0 bln for the quarter. At that time, the company was feeling mostly upbeat about its business, stating that North American water heater industry shipments remained resilient, buoyed by stable replacement demand and prebuy activity ahead of its March 1, 2024 price increase.
• However, AOS did warn in the Q2 earnings release that economic headwinds in China were persisting, giving the company some pause for the remainder of the year. Those concerns have come to fruition, as reflected in the steep fall off from the 2% sales increase in China seen last quarter.
• Unfortunately, China isn't the only soft spot. Sales in North America, which accounts for roughly 75% of AOS's total sales, were down modestly on a yr/yr basis in Q3 as both residential and commercial water heater orders were lower than expected in the quarter. Furthermore, the company believes that demand was impacted by larger-than-anticipated pre-buy activity in the first half of the year as customers looked to book orders ahead of the price increase.
• As a result of the above, AOS now sees FY24 revenue coming in at $3.8-$3.9 bln, representing a 1% decline at the midpoint of the guidance range. The good news is that the company expects to see some qtr/qtr improvement in North America water heater volumes. Additionally, India continues to be a source of strength with sales up 12% in local currency, following last quarter's increase of 16%.

The main takeaway is that China's real estate market woes are weighing heavily on AOS's business, while the high-interest rate environment here in the U.S. is creating another headwind. With China poised to launch new economic stimulus programs and with interest rates on a downward trajectory in the U.S., sales could begin to pick up again later this year and into 2025.