Sales of the commercial and industrial newly construction homes and buildings are influenced by cyclical factors such as interest rates, inflation, consumer spending habits, employment rates and other macroeconomic factors. Rising construction activities are the main driver for economic growth and also, for the Heating, Ventilation and Cooling (HVAC) industry. Surging sales of homes and new buildings have positively impacted this industry as the sales of HVAC equipment is highly correlated with the construction of new homes and buildings. Availability of easy financing has also supported the growth of HVAC equipment sales.
AAON, Inc. (AAON) is a leading HVAC player in U.S. and Canada. The company manufactures and sells air-conditioning and heating equipment. Its products consist of rooftop units, chillers, air-handling units, make-up air units, heat recovery units, condensing units, commercial-self contained units and coils. According to the company's annual report 2012, the company has a 14% market share in the rooftop market and 1% market share in the coil market.
A glance at the company's Financial Performance
The financial position of the company is quite strong. The company had a current ratio of 2.3, with its current assets totaling $91.5 million. Cash and investments accounted for 21.1% of the total current assets. Capital expenditure incurred in 2012 was $14.1 million. AAON has paid out total dividends of $8.9 million, which included a special dividend of $0.12 per share paid in December, 2012. Most importantly the company is operating at zero debt level and generates a return on equity of 21.1% on average.
The company has registered a consistent growth in its revenues over the four year period at a CAGR of 7%. Net sales for the year 2012 increased by 13.9%, or $36.9 million to $303.1 million, as compared to the same period in 2011. The increase in net sales was primarily due to the positive customer response for its new products, increased market share and price increases introduced earlier during the year. In addition, margins also improved due to the lower cost of raw material and increased product prices. In 2012, the price of copper increased by approximately 0.5% and the cost for steel and aluminum decreased by approximately 2.5% and 8.0% respectively, from a year ago. Since the beginning of the year 2013, the prices of copper, steel and aluminum have taken on a downward trend, which will further improve the company's margins.
The decomposition of ROE provides a deep insight into the company's performance. It highlights the strong areas of a company and the weak areas where it needs improvement. It is a basic way of analyzing how efficiently the company's management is utilizing the investors' money.
After 2011, ROE began to rise once again, which was mainly supported by the improving net margin. You can also see that the company has improved its ROE by reducing its financial risk which is reflected in the decreasing financial leverage ratio of the company. This has partially contributed to the improvement in the company's net margin. However, it is important to note that the company is currently operating with zero long term debt, which means that its financial leverage is totally based on short term liabilities. High dependency of ROE on its net margin reflects the strength of the company.
Though the revenue growth from new installations slowed down during the recession due to the fall in construction activity, steady demand for maintenance and repair services kept the company going. As the real estate market improves, so will the demand for company's products and services. Also, the initiatives taken by the government to reduce energy consumption will promote the installation of newer, more energy-efficient units. This will in turn increase the demand for the company's products.
The company is quite flexible in terms of revenue generation. In the year 2012, approximately 55% of the company's sales were generated from sales in the renovation and replacement markets and 45% from new construction. The proportion of sales coming from new construction versus replacement is related to the stage of construction/ development. Presently, the demand for new installations is rising due to the improving market conditions and it is expected that the new installation business will contribute a higher proportion to the company's revenue base in the future.
Industry Outlook and Conclusion
In the beginning of the year 2013, a research report published by the American Institute of Architects (AIA) forecasted a substantial increase in the nonresidential construction activity. AIA has projected construction spending for buildings to rise by 5% in 2013 and 7.2% in 2014. The construction of commercial facilities is expected to lead the upturn in the demand for AAON's products, with installation spending rising by almost 9% this year and nearly by 11% in the next year. Industrial construction spending is projected to increase moderately, while institutional construction activity may lag behind. AIA expects the healthcare industry to be the strongest institutional sector.
Overall, AAON has an optimistic future outlook. It also has a strong product portfolio along with a strong financial position. The company's increasing market share is the evidence of the increasing acceptance of its energy efficient products. Therefore, at current prices, the company's stock is a valuable opportunity for investors. I propose a buy recommendation for AAON as the company's stock price has a strong potential for appreciation in the coming years.