2023-05-23 14:48:02 ET
Summary
- Revenue growth should benefit from price increases, healthy backlog, good demand, and market share gains.
- Margins should benefit from price increases, productivity gains, and improving efficiency due to easing supply chain issues.
- The company is progressing towards being a mainstream player from a niche player.
- Valuation is lower than historical averages.
Investment Thesis
AAON, Inc. ( AAON ) is poised for revenue growth, thanks to several factors. Firstly, the company enjoys a healthy backlog level of $600 million, which should contribute to its growth. Furthermore, price increases and strong demand in the end-market, driven by long-term trends such as decarbonization, electrification, energy transition, and improved air quality, should also support AAON's revenue growth. The ongoing reshoring of manufacturing in the U.S. and the construction of data centers are additional factors that contribute to the company's long-term demand outlook.
Moreover, AAON is experiencing market share gains as it continues to expand its production capacity and improves lead times. This transformation from a niche player to a mainstream player is expected to further fuel the company's sales growth.
In terms of profitability, AAON is likely to witness margin expansion in the upcoming quarters. This should be driven by price increases, the resolution of supply chain issues, and productivity gains.
Furthermore, AAON's current valuation is trading at a discount compared to historical averages. This makes the stock an attractive investment opportunity.
Overall, considering the positive revenue and margin growth prospects, along with a reasonable valuation, AAON, Inc. is a good buy.
Revenue Analysis and Outlook
In my previous article , I highlighted AAON's robust end-market demand driven by secular trends such as decarbonization, electrification, energy efficiency, and improved air quality, which are expected to drive its revenue growth in the future. The company recently released its first-quarter results for 2023, and these secular trends provided a strong foundation for its performance during this period.
During the first quarter of 2023, AAON experienced solid demand and saw its sales growth further bolstered by improved backlog execution. This led to a significant year-over-year increase in organic volume, amounting to 23.5 percentage points. Additionally, price increases contributed to a 22 percentage point increase in sales growth. Consequently, the company achieved an impressive 45.5% year-over-year growth in sales, both organically and on a reported basis, reaching a total of $266 million.
AAON’s Historical Net Sales (Company Data, GS Analytics Research)
Looking ahead, I anticipate that AAON will maintain its trajectory of revenue growth in the upcoming quarters. The company is poised to benefit from multiple factors, including a healthy backlog, improved production capacity, and ongoing secular demand trends.
AAON's backlog has consistently demonstrated robust growth. In the first quarter of 2023, the backlog expanded by 30% year-over-year, reaching an impressive $600 million. Furthermore, the backlog also exhibited sequential growth of 9.5% compared to the fourth quarter. This significant year-over-year and sequential growth can be attributed to favorable lead times compared to peers and the good demand from the secular trends of decarbonization, electrification, energy efficiency, and improved air quality. These trends drive the demand for AAON's customized HVAC systems. Additionally, the growth of the backlog was further bolstered by BasX, which has been fully integrated into AAON. The company continues to benefit from increasing demand in the semiconductor and data center markets through BasX.
With a healthy backlog, expanding production capacity, and sustained demand from secular trends, AAON is well-positioned to continue its revenue growth trajectory.
AAON’s Order Backlog (Company Data, GS Analytics Research)
Additionally, as discussed in my previous article , the company is actively focused on enhancing production capabilities and meeting the demands of the end market by increasing its workforce. In the first quarter, AAON experienced a notable 27.3% year-over-year increase in total headcount, and a 10.4% sequential increase. It is worth noting that the company previously faced limitations in terms of physical facilities, which constrained its ability to add incremental headcount to meet customer demand.
However, the company's ongoing investments in expanding manufacturing capacities in Missouri, Texas, and Oregon, which are expected to be operational by mid-2023, should enable AAON to continue increasing headcounts without encountering physical constraints. These investments in manufacturing capacity and workforce expansion will contribute to volume growth and support sales growth. Overall, with the combination of a strong backlog and efforts to expand production capacity and workforce, AAON is well-positioned to sustain its sales growth trajectory.
AAON Headcount (Q1 2023 Earning Presentation)
Additionally, AAON has gained market share in recent years due to its superior lead times compared to its competitors during a period of supply chain challenges. While its competitors are now catching up, I believe AAON will benefit from its increased production capacity resulting from the aforementioned investments in headcounts and capacities. This should enable the company to further reduce lead times compared to its peers and should help it continue gaining market share. AAON should also benefit from narrowing price differentials with competitors thanks to recently implemented SEER2 guidelines (related to efficiency of HVAC products) which increased average price point for its competitors while AAON was not impacted as its products were already high in efficiency. Furthermore, in April, the company unveiled an exploration center at its Tulsa headquarters—a 27,000-square-foot showroom showcasing AAON equipment alongside other market alternatives. This facility will assist sales representatives in conveying the value proposition of AAON equipment to customers. These tailwinds should support AAON in maintaining its market share growth and driving sales growth. The company's transformation from a niche player to a mainstream player also contributes to a positive outlook for multi-year revenue growth.
In summary, I remain optimistic about AAON's sales growth prospects in the short and long term thanks to the strength of the company's backlog, its industry-leading lead times, and the value proposition offered through its expertise in customized commercial HVAC systems.
Margin Analysis and Outlook
During the first quarter of 2023, AAON successfully expanded its margin through price increases and improved productivity, effectively mitigating supply chain challenges. This led to a noteworthy year-over-year increase in gross margin of 380 basis points, reaching 29%, and a significant year-over-year increase in operating margin of 400 basis points, reaching 16.6%. However, in sequential terms, the company experienced a temporary dip in margin due to a one-time cost associated with onboarding new headcount.
AAON’s Historical Gross Margin and Operating Margin (Company Data, GS Analytics Research)
Moving forward, I anticipate that the company will resume margin recovery and successfully expand to pre-pandemic levels. The one-time costs associated with onboarding new employees are not expected to recur in the coming quarters, which should contribute to sequential margin growth. Additionally, the majority of the planned headcount additions are anticipated to be made in the first half of the year. As we progress through the year and production increases due to the expanded workforce, productivity gains and sales leverage are likely to improve, thereby supporting margins in the latter part of the year.
Furthermore, it is important to note that the company has been grappling with supply chain challenges over the past couple of years. As the supply chain challenges gradually subside, I anticipate a notable improvement in efficiency, which will contribute significantly to expanding margins. Moreover, as the company continued to increase prices over the last few quarters, orders in the backlog are at higher prices compared to the ones the company realised in revenues last quarter. This should provide additional support. Therefore, I maintain an optimistic outlook for both year-over-year and sequential margin expansion in the upcoming quarters.
Valuation and Conclusion
The company is trading at a 32.43x FY23 consensus EPS estimate of $2.79 and a 27.69x FY24 consensus EPS estimate of $3.28, which is at a discount to its historical 5-year average forward P/E of 42.16x. I won’t call the stock cheap, but it is still reasonably valued if we look at its phenomenal EPS growth potential (~50.13% Y/Y in FY23 and 17.34% Y/Y in FY24 according to consensus estimates.)
AAON Consensus EPS Estimates (Seeking Alpha)
Given the good long-term revenue and margin growth prospects due to the transition from niche player to mainstream player and multiyear secular demand trends, I believe the stock should see further upside over the coming years. So, I continue to have a buy rating on the stock.
For further details see:
AAON Is A Good Buy At Current Levels