AAON, Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

AAON is a manufacturer of premium, custom air-conditioning and heating equipment, catering to commercial and industrial markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview AAON, Inc. is a US-based company focused on manufacturing, marketing, and selling air-conditioning and heating equipment. They specialize in providing custom-built and standard products for commercial and industrial environments. Their offerings include rooftop units, chillers, indoor air handlers, and other related equipment. A significant portion of their sales, about 68.5%, comes from the U.S., while their operations in Mexico and Canada also contribute revenue.

A key aspect of AAON’s strategy lies in the ability to customize equipment to the specific needs of their customers. This allows them to serve a wide variety of industries and applications.

Revenue Distribution:

  • AAN Oklahoma: The segment that designs, manufactures, and sells custom, air conditioning units, along with other components.
  • AAON Coil Products: Manufacturing and selling components, primarily coils and related parts to the other business units.
  • BASX: Provides custom designed solutions for specific customers.

Industry Trends and Competitive Landscape:

  • The HVAC industry is experiencing growth due to a number of factors including increased demand from both industrial and commercial sectors.
  • Energy efficiency standards and the need for indoor air quality are also driving the need for more advanced HVAC systems. The market is influenced by regulatory mandates and environmental factors.
  • The competitive landscape includes a mix of established players (like Carrier, Lennox, and Trane), as well as smaller niche manufacturers.
  • AAON’s differentiation lies in their custom design approach and quick turnaround time for specialized solutions.

Financial Metrics & Analysis

  • Margins: AAON has seen a strong gross margin ranging between 33% and 36% in the last 2 years and around 31% historically, indicative of their pricing power. Operating profit margins are also healthy at around 12-15%. The recent expansion in the manufacturing operations and price increases have had a positive impact on gross margins.
  • Revenue Growth: AAON has generally grown revenues over the past few years with increases between 10% to 17%.

However, in the latest quarterly report, net sales increased by a substantial 30.5% year-over-year, indicating a massive acceleration in their growth. Their backlog is also at a record level of over 1.4B.

  • Profitability: Profitability is consistent with ROICs trending towards 20% over the years. Also, the company has a healthy net income percentage of around 9%-12%.
  • Recent Financials:
    • Revenue: AAN Oklahoma, AAON Coil Products, and BASX showed significant growth in net sales in the most recent quarters, up 26.5%, 24.1% and 45.5% respectively. Overall gross profit margins improved from 30.4% to 36%.
    • Net Income: AAN Oklahoma was profitable. AAON Coil Products increased its profits from -0.7% to 18.6%. BAX had a loss that is not clearly defined in the provided data. Overall, company-wide, net income increased by a whopping 150% between the same periods.
    • Capital Structure Overall debt has gone down and cash holdings are good. With a debt-to-equity ratio of 0.3 in the latest quarter, the company’s balance sheet looks robust.

    The increase in net sales shows demand for their products. And even after the big investments, profits have exploded. This indicates the demand and pricing power of the company.

Moat Assessment AAON’s moat is a solid but not extraordinary one that is rooted in a combination of the following:

  • Switching Costs: While not explicit, there is some level of switching costs. Given the custom nature of the solutions, a customer is unlikely to change vendors for every project. Furthermore, if a customer is already used to a vendor, there is some benefit in familiarity. It is highly probable that current customers are likely to stick with AAON.
  • Scale Economics: Although not a wide-moat company, AAON’s vast distribution network and manufacturing capacity does offer a competitive edge and higher profitability. The company also manufactures its own coil systems and is vertically integrated, thereby adding some to their economies of scale.
  • Intangible Assets: The brand has been built up and known for high-quality customized solutions for very specific clients. This brand also has a network effect, but these are not wide as of yet. Based on this mix, a narrow moat rating is justified.
**Moat Rating: 3/5**

Risks to the Moat

  • Economic Cyclicality: The HVAC market is heavily dependent on construction activity which can be highly cyclical, making demand uncertain during downturns. A potential recession or a slowdown in the building/manufacturing industry can impact the demand for AAON’s products and therefore impact sales.
  • Customer Concentration: Some of their revenue comes from a small number of very large customers, which makes them vulnerable to fluctuations and to losing a few major clients.
  • Commodity Price Inflation: AAON’s profitability is subject to increases in the cost of materials, especially copper and aluminum, used in their products. Although recent results suggest they can pass this on to customers, this might not hold in every situation.
  • Competition: The industry is competitive and the major players can try to replicate AAON’s strategies. Furthermore, if competition gets stronger, this could put a downward pressure on prices and therefore margins.

Understandability: AAON is a relatively easy business to understand because they are in a traditional industry and there is not a lot of complexity in their products. They make AC units and related equipment, and their sales are primarily based in the US. Understandability: 3/5

Balance Sheet Health AAON has a reasonably strong balance sheet, with manageable debt. However, the large amount of debt due to the recent acquisitions will need to be observed for future effects on profitability. Balance Sheet Health: 4 / 5

Recent Concerns and Management’s Responses The main concern is the effects of inflation and supply chain disruptions. According to the latest reports, demand remains strong, while supply chain issues are starting to become more manageable. Management acknowledges the price increases to offset any inflationary pressures on their expenses. They have also made several investments in production facilities, thus reducing risk in their supply chains. They expect to increase sales significantly while maintaining strong profit margins.

Finally, I added information about the key risk to the company’s ability to generate value, it would be that the competition gets so intense that AAON’s pricing power goes away. And without that power, returns will suffer dramatically.