2023-06-02 06:54:18 ET
Summary
- AAON Inc. reported a 45.5% YoY increase in sales to a record $266 million for Q1 2023, attributed to customer retention and successful management of shortages.
- The company has a strong backlog of orders worth $600 million and a solid balance sheet, but its current valuation is considered too high for a good entry point.
- AAON faces risks such as negative cash flows and high valuation, but its financial state remains stable as long as it doesn't take on more debt.
Investment Summary
AAON Inc (AAON) is a company specializing in the manufacturing and sale of HVAC equipment. Their extensive product line includes various HVAC solutions suitable for both commercial and residential applications. Some of their notable offerings encompass rooftop units, air handling units, condensing units, chillers, and heat recovery units.
The variety of products the company has resulted in an impressive last earnings report from the company. Sales rose 45.5% YoY to a record $266 million for the first quarter to kick off 2023. The rise in sales was attributed to the company's ability to retain customers and manage shortages in some parts very successfully. The company keeps a solid balance sheet and growth is estimated to continue both for the top and bottom lines. But I fear the current valuation doesn't really offer a good enough entry point. The company is trading at over 30x forward earnings which is quite a premium to pay for a company not necessarily able to grow revenues 20% YoY like some other growing companies with similar multiples. Because of this, I will keep a hold rating for AAON for now.
Quarterly Result
As mentioned, AAON had a fantastic first quarter to the start of 2023, with sales increasing 45.5% YoY. But I think another highlight from the quarter has to be the margins making a move to the upside, increasing 380 basis points. Some of the measures taken to help with this increase were price hikes implemented in 2022 and a successful moderation of costs within the company.
The company does have a solid history of steady net margins, but it seems they are back on the uptrend again and I hope to see the next few quarters have equally as satisfying results as the last one.
Looking ahead, the company seems to be positive about its ability to continue increasing margins as they hold a strong position in the market currently. They have proven themselves able to maneuver around hurdles and come out on top whilst still increasing prices and margins. But there are some uncertainties facing the industry in the coming years. The Department Of Energy is requiring new HVAC equipment to utilize a lower global warming potential, which goes into effect on January 1, 2025. Until then, there is a race to get technology and products up to par with the requirements to not risk being shut out of the market.
Backlog (Investor Presentation)
But AAON has been able to gather up quite a strong backlog of orders, currently at just under $600 million, which will help keep revenues steady and capital available to invest into new technologies hold steady with the market share they have. As a reference to the market, the TAM of the nonresidential HVAC packaged rooftop market is approximately $6 billion according to the company, leaving a lot of room for AAON to continue to grow. Investors holding shares in the company can in the meantime enjoy a nice dividend that doesn't harm the balance sheet and hasn't led to massive share dilution. Looking at the coming quarters, the margin development will be especially key to watch as well as the development of the backlog.
Risks
Looking at risks, I think the slightly negative cash flows will be a cause of concern if they continue to remain that way and don't show any sign of improvement. The negative cash flows will be a thorn in the side of the company as it will be necessary to dilute shares in order to raise capital for investments, which of course hurts any investor in the company. Now, dilution hasn't been at a worrying level yet, outstanding shares have only increased about 2% in the last 2 or so years.
Besides the cash flows, the obviously quite high valuation the company is trading at brings in my opinion a lot of risk for a correction if an earnings report doesn't please investors enough. Paying over 30x forward earnings is quite rich and there needs to be more growth than what AAON is having to justify such a number.
Financials
Looking at the financials of the company, they seem to be running a pretty tight ship right now with a very small cash position of just $2.5 million, down from $5.4 million in the previous quarter. Not the move I like to see, especially when the cash flows are negative and the company is still issuing a dividend.
But the company still has more than 3x as many total assets compared to total liabilities, which makes me at least a little more reassured about the company's financial state. Long-term debts aren't drastic, sitting at $83 million currently. To further help highlight the little impact I think the debt has on the company's ability to invest capital without risking defaulting is that the net debt/EBITDA ratio is under 1 currently, more specifically at 0.47. The financial state of the company should remain sound as long as they don't take on more debt, which would potentially shift the balance here quite significantly and make the company even less of a buy. The forward p/b sits high just like the p/e at above 6 right now. Which really doesn't scream value to me.
All in all, I find the balance sheet of AAON right now to be quite stable, as long as they don't take on any more debt. That would in my opinion cause a lot of concern as shares might be diluted at a faster rate to help pay down the debt. The cash position isn't built out large enough either to fund such a move by the company. It seems the company has a narrow line to walk down until it can get back to positive cash flows, which would help fund more debt.
Valuation & Wrap Up
Looking at the valuation, I think I have made the case here quite obvious that I think AAON is too richly valued right now to justify a buy. Paying above 30x forward earnings is too much, especially when it doesn't seem the company will be growing revenues at 20% yearly for enough years ahead to justify the multiple. This high multiple also leaves room for a potential correction to the downside to reflect the actual growth and value of the company.
Seeing as AAON has exposure to the infrastructure pace in the US, their revenues will be dictated by the amount of demand this market sees going forward. The US economy isn't growing at the same pace as in previous years, and this could be interpreted as the infrastructure boom perhaps not being as fast or large as previously anticipated. That would put the future revenues of AAON into question. I think there are better and more stable companies instead that offer similar exposure to infrastructure spending in the US. Companies in the steel industry have direct exposure and generally speaking strong balance sheets with buyback programs and quarterly dividends. But to conclude, I think AAON has shown they are able to grow in a challenging market, but the valuation right now doesn't come close enough to a buy. I find the outlook to be positive however and will be rating AAON a hold for now.
For further details see:
AAON: Valuation Is Too Rich To Make A Buy Case