בס״ד

Plumbing For Profits in The Steamy World of Water Heaters (AOS)

Posted on November 24, 2021

Milwaukee’s A.O. Smith Corporation (NYSE:AOS) has been heating water through sub-zero Wisconsin winters since 1874.

Today, the company manufactures both gas and electric units and sells them to individuals and institutions across the planet.

At the end of October, AOS beat earnings estimates and buyers went warp-wild on the stock, creating the great money-making opportunity before us today.

Not to worry, sugar.

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Anyway, there’s a lot to be said, so let’s start with the fundamentals –

  • Price/Earnings is a hefty 28.56 (a bit bloaty for a metal-molder, in our opinion).
  • Dividend Yield is 1.36%,
  • Price to Book is a sky-high 6.92, and… wait for it –
  • Insiders have sold 43.06% of their stock over the last six months, for a dollar amount of just over $50 million.
  • More to the point, $36 million of that total was dumped in just the last three weeks!

As mentioned above, better-than-expected Q3 results sent the stock into geyser mode (the not-so-surprising result of diminished expectations).

Additionally, the company admitted that a great proportion of its third-quarter revenue was generated by inflation.  The company merely passed on its inputs to consumers.

Water heater prices are up some 50% this year.

Now take a look at the chart –

Technicals point to a top-in-process –

  1. To begin, RSI has been at or near overbought since the post-earnings buying spree began at the end of October (in green), and
  2. MACD is clearly rolling over, having lost significant momentum since the fever peaked. We expect technical traders will now recognize a receding tide and begin selling in earnest.
  3. Volume spiked after earnings but quickly fizzled (in black), as traders realized Q3 was likely an aberration and buoyant guidance was less than trustworthy. Insider selling is also indicative of an internal loss of faith in current prices.  Either way, there’s been zero follow-through.
  4. A 30% price rise in three weeks is untenable (in red). Buyers, at this point, are scarce.

Which leads us to ask the Al-mighty Living G-d of Israel to aid us with the following –

A Jew and His Gold recommends you consider selling the AOS April 14th 80/85 CALL spread* for a credit of $2.00 (6.80/4.80) and buying the AOS April 14th 85/80 PUT spread** for $2.90 (7.40/4.50).  Total debit on the affair is $0.90.

[*Sell the 80 CALL and buy the 85 CALL.  **Buy the 85 PUT and sell the 80 PUT.]

Rationale: we pay $0.90 for a potential maximum gain of $4.10 NET on the trade (455%!).

Max loss is limited to $5.90 (difference between the CALL strikes plus our initial debit).

We’ve a long time to realize profits, but will likely close early on any significant decline.

Many happy returns!

Matt McAbby

 

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