2023-08-17 02:56:05 ET
Summary
- AAON is a company that sells air conditioning and heating equipment in the US and Canada.
- The company has a strong financial history and impressive growth, but the growth seems to be priced in - my DCF model estimates a downside of 19%.
- As the company's growth could continue for longer than my DCF model estimates and as the company has a low-risk profile, I have a hold rating for the stock.
AAON Inc. ( AAON ) is a company that sells air conditioning and heating equipment in the United States and Canada. Although the company has a fantastic financial history with impressive growth, I have a hold-rating for the stock as the company's growth seems to already be fully priced into the stock.
The Company & Financials
AAON provides rooftop units, data center cooling solutions, cleanroom systems, chillers, packaged outdoor mechanical rooms, air handling units, makeup air units, energy recovery units, condensing units, heat pumps, coils, and controls:
Some of AAON's Offering (aaon.com)
The company has had an impressive history on the stock market; the stock's price has increased over 100-fold over its history from the 1990s:
AAON's Stock Chart (Seeking Alpha)
To achieve the stock price run, AAON has a solid track of growth, demonstrated by the company's growing backlog:
AAON's Backlog (AAON Q2 Earnings Presentation)
The company's revenues have grown at a compounded annual rate of 12% for the past nine years:
AAON's Revenues (Seeking Alpha)
The growth seems to have accelerated in 2022, as the year's growth amounted to 66%. This growth doesn't seem to be stopping for the time being, as in Q2 AAON's revenues grew by 36%, of which unit growth was 16% - inflation seems to amount to a good part of the company's current growth.
A slowdown in revenues could be due in the coming quarters, as the backlog saw a decrease of -12.3% in Q2 from the previous quarter. I don't expect a big slowdown to come in Q3, though, as the company has communicated positively about the upcoming quarter; in their Q2 earnings presentation, AAON communicated towards modestly growing sales and EPS. Furthermore, the company's CEO Gary Fields told investors in AAON's Q2 earnings call :
I want to provide some information on our outlook for the rest of the year. Based on the size and improved margin profile of the backlog and the increased production capacity and improving productivity that we anticipate, we continue to expect sales and earnings will improve sequentially in Q3. We now anticipate pricing will be a mid-double-digit contributor to sales growth for the year, up from low double digits."
The company didn't discuss an outlook any further - I believe a temporary slowdown in Q4 could be due, as backlogs start to affect the company's sales.
AAON has had a solid operating margin for most of its history. In 2022, the company achieved an operating margin of 14.4%, with a large increase expected to happen in the current year as AAON has significantly increased their prices. In Q2 the operating margin was 19.4% compared to previous year's 9.9% for the same period, as price increases have raised AAON's gross margin significantly. Analysts are expecting an operating margin of 19.2% for 2023, a 4.8 percentage point increase from 2022, and a margin that's near the company's all-time highs.
AAON's Operating Margin (Tikr)
The profitability is also very good on a capital basis, as AAON's trailing return on equity is an impressive 25.88% - any growth that the company achieves is highly valuable.
AAON's balance sheet runs thin on both sides - the company only has a cash balance of $5.2 million , and interest-bearing debts totalling $78.5 million. The company doesn't seem to leverage debt well to its advantage, as the company's market value is . The debt AAON has is in long-term debt entirely, with no part being in current portion. The company started leveraging debt in 2021, as prior to the year the company had no interest-bearing debts. As air conditioning revenues seem to run quite steadily, I believe the company would be better off if they had some more outstanding debt for cheaper capital.
Valuation
As AAON has had a solid track of growth, the company has always been quite expensive on a price-to-earnings basis with a current forward ratio of 30.41, compared to the historical figure of 32.76 from the last ten years:
Going further into the valuation, I modelled a discounted cash flow model scenario to further demonstrate AAON's valuation and to approximate a fair value for the stock.
In the model I estimate AAON's growth to be 26% for the current year - this would represent a large slowdown in H2, as in H1 the growth was 40.4%. Going forward, I estimate growth that is slightly above AAON's historical rate, as the company seems to invest heavily to improve manufacturing capacity - for 2024 I expect a growth of 18%, with the growth slowing down slowly.
As AAON has demonstrated that it can push higher prices to customers, I believe the company can maintain its impressive margin. I estimate the company's EBIT margin to be 18.47% for 2023, with slight further increase in the future. These estimates along with a cost of capital of 8.72% construct the following DCF model scenario, with a fair value estimate of $51.21, a price that's 19% below the stock's current price:
DCF Model of AAON (Author's Calculation)
To get to the weighted average cost of capital of 8.72%, I constructed a capital asset pricing model:
CAPM of AAON (Author's Calculation)
As AAON doesn't have significant debts to estimate their interest rate from, I inputted an estimate of 6% - a rate that should have a healthy margin of error as the company seems to be low in risk. The United States' bonds yield around 4%, which the estimate of 6% is well above of - I believe similar companies pay around a similar interest rate for debt. I expect the company's debt-to-equity ratio to be at 15% in the long term, well above current levels but still a moderate amount; AAON has been drawing small amounts of debt already, and the trend could continue into the future.
On the cost of equity side, I have the United States' 10-year bond yield as the risk-free rate, with the yield currently being 4.18%. The equity risk premium of 5.91% is Professor Aswath Damodaran's estimate for the United States, made in July. AAON's beta is estimated to be 0.81 according to Yahoo Finance - as the company has almost no debt and air conditioners aren't cyclical in nature, the company should be low in systematic risk. Finally, I add a liquidity premium of half a percent into the cost of equity, adding up to a 9.47% cost of equity and a WACC of 8.72%.
Takeaway
At $63.05 a share, I believe AAON's growth is priced in for a long period. Although the company's fantastic run on the stock market could continue, I believe AAON's growth would need to continue for a very long period for the stock to continue its run when considering the stock's current price. For this reason, I have a hold-rating for the stock.
For further details see:
AAON's Growth Story Isn't Stopping Yet