AAON (AAON)

Heating and cooling solutions company AAON (NASDAQ:AAON) reported revenue ahead of Wall Street’s expectations in Q1 CY2025, with sales up 22.9% year on year to $322.1 million. Its non-GAAP profit of $0.37 per share was 57% above analysts’ consensus estimates.

Company Overview

Backed by two million square feet of lab testing space, AAON (NASDAQ:AAON) makes heating, ventilation, and air conditioning equipment for different types of buildings.

Many HVAC and water systems companies sell essential, non-discretionary infrastructure for buildings. Since the useful lives of these water heaters and vents are fairly standard, these companies have a portion of predictable replacement revenue. In the last decade, trends in energy efficiency and clean water are driving innovation that is leading to incremental demand. On the other hand, new installations for these companies are at the whim of residential and commercial construction volumes, which tend to be cyclical and can be impacted heavily by economic factors such as interest rates.

Competitors also making HVAC products include Lennox (NYSE:LII), Carrier Global (NYSE:CARR), and Trane (NYSE:TT)

A company’s long-term sales performance can indicate its overall quality. Any business can have short-term success, but a top-tier one grows for years. Luckily, AAON’s sales grew at an incredible 20.7% compounded annual growth rate over the last five years. Its growth surpassed the average industrials company and shows its offerings resonate with customers, a great starting point for our analysis.

Long-term growth is the most important, but within industrials, a half-decade historical view may miss new industry trends or demand cycles. AAON’s annualized revenue growth of 13.9% over the last two years is below its five-year trend, but we still think the results suggest healthy demand.

This quarter, AAON reported robust year-on-year revenue growth of 22.9%, and its $322.1 million of revenue topped Wall Street estimates by 10.9%.

Looking ahead, sell-side analysts expect revenue to grow 15.7% over the next 12 months, an improvement versus the last two years. This projection is eye-popping and implies its newer products and services will fuel better top-line performance.

All else equal, we prefer higher gross margins because they make it easier to generate more operating profits and indicate that a company commands pricing power by offering more differentiated products.

AAON’s unit economics are better than the typical industrials business, signaling its products are somewhat differentiated through quality or brand. As you can see below, it averaged a decent 30.5% gross margin over the last five years. That means for every $100 in revenue, roughly $30.52 was left to spend on selling, marketing, R&D, and general administrative overhead.

AAON’s gross profit margin came in at 26.8% this quarter, marking a 8.4 percentage point decrease from 35.2% in the same quarter last year. AAON’s full-year margin has also been trending down over the past 12 months, decreasing by 4.5 percentage points. If this move continues, it could suggest a more competitive environment with some pressure to lower prices and higher input costs (such as raw materials and manufacturing expenses).

AAON has been a well-oiled machine over the last five years. It demonstrated elite profitability for an industrials business, boasting an average operating margin of 16.8%.

Analyzing the trend in its profitability, AAON’s operating margin decreased by 2.1 percentage points over the last five years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability.

In Q1, AAON generated an operating profit margin of 10.9%, down 7.1 percentage points year on year. Since AAON’s gross margin decreased more than its operating margin, we can assume its recent inefficiencies were driven more by weaker leverage on its cost of sales rather than increased marketing, R&D, and administrative overhead expenses.

We track the long-term change in earnings per share (EPS) for the same reason as long-term revenue growth. Compared to revenue, however, EPS highlights whether a company’s growth is profitable.

AAON’s EPS grew at an astounding 18.2% compounded annual growth rate over the last five years. However, this performance was lower than its 20.7% annualized revenue growth, telling us the company became less profitable on a per-share basis as it expanded.

Diving into AAON’s quality of earnings can give us a better understanding of its performance. As we mentioned earlier, AAON’s operating margin declined by 2.1 percentage points over the last five years. Its share count also grew by 5.1%, meaning the company not only became less efficient with its operating expenses but also diluted its shareholders.

Like with revenue, we analyze EPS over a more recent period because it can provide insight into an emerging theme or development for the business.

For AAON, its two-year annual EPS growth of 14.7% was lower than its five-year trend. We still think its growth was good and hope it can accelerate in the future.

In Q1, AAON reported EPS at $0.37, down from $0.46 in the same quarter last year. Despite falling year on year, this print easily cleared analysts’ estimates. Over the next 12 months, Wall Street expects AAON’s full-year EPS of $1.92 to grow 26%.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

AAON has shown poor cash profitability over the last five years, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 1.2%, lousy for an industrials business. The divergence from its good operating margin stems from its capital-intensive business model, which requires AAON to make large cash investments in working capital and capital expenditures.

Taking a step back, we can see that AAON’s margin dropped by 21 percentage points during that time. If the trend continues, it could signal it’s in the middle of a big investment cycle.

AAON burned through $55.94 million of cash in Q1, equivalent to a negative 17.4% margin. The company’s cash flow turned negative after being positive in the same quarter last year, which isn’t ideal considering its longer-term trend.

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was it capital-efficient? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).

AAON’s five-year average ROIC was 20.7%, placing it among the best industrials companies. This illustrates its management team’s ability to invest in highly profitable ventures and produce tangible results for shareholders.

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Uneventfully, AAON’s ROIC has stayed the same over the last few years. Rising returns would be ideal, but this is still a noteworthy feat since they're already high.

AAON reported $994,000 of cash and $252.4 million of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company’s debt level isn’t too high and 2) that its interest payments are not excessively burdening the business.

With $268.4 million of EBITDA over the last 12 months, we view AAON’s 0.9× net-debt-to-EBITDA ratio as safe. We also see its $136,000 of annual interest expenses as appropriate. The company’s profits give it plenty of breathing room, allowing it to continue investing in growth initiatives.

We were impressed by how significantly AAON blew past analysts’ EPS expectations this quarter. We were also excited its EBITDA outperformed Wall Street’s estimates by a wide margin. Zooming out, we think this was a good print with some key areas of upside. The stock traded up 7% to $97.51 immediately after reporting.

Updated: May 21, 2025 at 11:08 PM EDT

The latest quarterly earnings matters, sure, but we actually think longer-term fundamentals and valuation matter more. Investors should consider all these pieces before deciding whether or not to invest in AAON.

AAON is a rock-solid business worth owning. For starters, its revenue growth was exceptional over the last five years. And while its cash profitability fell over the last five years, its astounding EPS growth over the last five years shows its profits are trickling down to shareholders. Additionally, AAON’s projected EPS for the next year implies the company’s fundamentals will improve.

AAON’s P/E ratio based on the next 12 months is 41.6x. Expectations are high given its premium multiple, but we’ll happily own AAON as its fundamentals shine bright. Investments like this should be held patiently for at least three to five years as they benefit from the power of long-term compounding, which more than makes up for any short-term price volatility that comes with high valuations.

Wall Street analysts have a consensus one-year price target of $111.25 on the company (compared to the current share price of $100).

Want to invest in a High Quality big tech company? We’d point you in the direction of Microsoft and Google, which have durable competitive moats and strong fundamentals, factors that are large determinants of long-term market outperformance.

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