American Standard: Flush with Success


By Eric Wahlgren Despite recent rallies, stocks are still pretty much in the toilet. One exception is American Standard (ASD), which happens to make johns, bidets, and other bathroom and plumbing products. In fact, this rather bland business helped the Piscataway (N.J.) company offset recent weakness in its commercial air-conditioning division, where American Standard derives the bulk of its sales.

Thanks in part to this kind of diversification (along with manufacturing braking systems for cars and trucks), American Standard has seen its stock gain nearly 2.1% year-to-date, closing at $69.64 on Aug. 6. Compare that with a decline of almost 25% in the Standard & Poor's 500-stock index, to which American Standard was added in May in a nod to its rising profile and financial strength.

HIGHEST RATING. The good news for investors is that most Wall Street pros think American Standard's days of outperformance are far from over. The layoffs and other cost-cutting moves it has made to cope with the economic downturn are expected to pay off even more when the commercial air-conditioning market comes back. That's expected to happen late in 2003. In the meantime, American Standard's other units show little sign of slowing down.

"Trends will get better for them," says Michael Jaffe, director of industrial research for S&P in New York. "But if a company of this sort is able to maintain a pretty solid pace during a pretty lousy economy, it's already doing a pretty nice job."

Jaffe has a buy rating -- S&P's highest, which it refers to as five STARS -- on the stock, believing its intrinsic value (an S&P valuation model based on future cash-flow estimates and other factors) could be about $109, which would be 56% more than its current price. (Like BusinessWeek Online, S&P is a unit of The McGraw Hill Companies and has no investment-banking relationship with the companies it rates.)

A STOCK TO SIT ON? In fiscal 2002, Jaffe expects American Standard's net income to rise 27%, to $375 million, or $5.10 a share, on 2.7% higher sales of $7.7 billion. That compares to 2001 net income of $295 million, or $4.04 a share, on sales of $7.5 billion. (2001 figures included special items affecting comparisons.) In 2003, Jaffe sees the company posting 15% higher net income of $430 million, or $5.80 a share, on a 3.9% sales increase to $8 billion.

Despite these earnings prospects, American Standard's stock is still pretty cheap at about 12 times his 2003 earnings estimate, Jaffe says. Even if profits are estimated using S&P's core earnings accounting, a new standard that factors in items like stock-option awards and pension gains, Jaffe says "it still looks modestly valued to me." The S&P 500 is trading at about 15 times 2003 earnings in comparison, according to earnings-tracking service First Call/Thomson Financial.

American Standard's eclectic mix of products and services -- everything from bathroom fixtures to Mercedes brake components to air-conditioning systems for the Boston Convention Center -- has helped it prosper in trying times. On July 17, 2002, it posted second-quarter earnings of $126 million, or $1.71 a share, on revenues of $2.09 billion, which was at the high end of analysts' expectations of $1.61 to $1.74.

COMMODORE OF THE COMMODES. The solid quarterly results came despite the fact that its air-conditioning sales (which made up 63% of revenues in 2001) dropped 2%. This group, whose brands include Trane and American Standard, saw residential air-conditioning sales increase, but the commercial business was burned as companies continued to put off upgrades or new installations.

Coming to the rescue, however, was the plumbing division (about 24% of 2001 sales), where second-quarter revenues rose 10%, as Americans kept buying homes or remodeling in nearly record numbers. Brands in this unit include American Standard, Ideal Standard, Porcher, Armitage Shanks, and Dolomite.

American Standard's vehicle-control systems division sells products under the name of WABCO -- inventor of antilock braking systems for trucks and buses. It contributed 13% of sales in 2001 and has also made a strong showing. A major player in Europe, the group logged 13% higher sales due in part to heavier demand in the aftermarket. WABCO managed this boost even though the Western European truck and bus markets witnessed a 4% production decline.

PRODUCTIVITY GAINS. American Standard has "good profits and leading market positions in all of its businesses," says Jim Lucas, an analyst at Philadelphia investment firm Janney Montgomery Scott, who has a buy rating on American Standard. (Lucas' firm doesn't own any shares nor does it have any banking relationship with the company). Adds Lucas: "They have a nice mix between industrial and consumer businesses, and between North American and international."

Indeed, American Standard operates in some 50 foreign countries, and operations outside the U.S. represented about 43% of 2001 sales. Lucas has an $81 price target, which means he thinks they could appreciate an additional 16% in the next year or so.

The company's diversity isn't the only reason analysts are upbeat on the stock. They're also keen on the new management team led by Chairman and Chief Executive Fred Poses, the former AlliedSignal president and chief operating officer who took the helm in January, 2000. Since then, Poses has continued to increase productivity and streamline operations, cutting about 1,700 jobs last year from a global workforce that's now about 60,000.

TRIMMING DEBT. Management also has been working on cutting some hefty debt, which American Standard took on during a leveraged buyout by merchant bank Kelso & Co. in 1988. (It returned to being a publicly traded company in 1995.) Today, it still carries some $2.1 billion in debt. But Poses & Co. have been dutiful about generating free cash flow -- some $350 million is expected in 2002 -- in part to alleviate the burden.

"They're really committed to the bottom line by continuing to pay down debt, and that reduces interest-rate expense," says Lawrence Horan, director of research at Parker/Hunter, a boutique investment-banking and research firm in Pittsburgh, which has no investment banking relationship with American Standard. Horan also has a buy rating on the stock and a 12-month price target of $95.

The push to reduce debt is showing signs of progress, analysts say. Interest expense in the second quarter fell by $11 million, even though that decline was partially offset by an increase in corporate and other costs. What's more, shareholder's equity turned positive (assets exceeded liabilities) in the second quarter for the first time since American Standard went public seven years ago. "The balance sheet is improving," says Lucas. "The management team is very solid. All of these are reasons to like the stock."

NESTING TREND. Investors do have to consider some risks, however. American Standard's debt is still high, says Lucas, although no one doubts its ability to pay it down. Moreover, just when big businesses will be ready to spring for new cooling systems is uncertain. And any chill in consumer spending could hurt the plumbing business, which seems to have benefited from the nationwide nesting trend. "Any slowdown would have more of an impact," says Lucas.

CEO Poses says the debt level is manageable, pointing out that it's already down substantially from 1999's $2.6 billion. "We're comfortable," he says. "We have good [debt] ratings." Although he concedes that the commercial air-conditioning market is "tough," he also points out that certain segments remain healthy, including sales to schools, hospitals, and municipalities. The aftermarket business, which includes service and repairs, will continue to grow at double-digit rates, he adds.

As for the consumer business, Poses doesn't see "any slackening." In fact, American Standard, which boasts that its products are found in three out of five U.S. bathrooms, sees this area as key for growth. It's introducing more "suites," or sets of products, such as matching sinks and toilets, that Poses says will help drive expansion.

COMFORT STOCK. Growth should also come from the WABCO unit, which is rolling out an automatic transmission system for trucks in Europe, where most heavy vehicles still have manual gearboxes. "This is a company that has grown very nicely and has wonderful brands and a wonderful market position," Poses says.

Investors have seen vast sums flushed down the drain with the declining stocks of outfits whose flashy products and services failed to deliver the monster returns they promised. So these days, given what many market watchers say are American Standard's relatively cheap shares, it's no surprise that the prospect of above-average gains from some pretty mundane products is winning converts. Wahlgren covers the markets for BusinessWeek Online in New York


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