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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, ladies and gentlemen, and welcome to the A. O. Smith Corporation Fourth Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded.
I would now like to turn the conference over to your host, Patricia Ackerman, Vice President, Investor Relations and Treasurer. You may begin.
Thank you, Andrew. Good morning, ladies and gentlemen and thank you for joining us on our 2017 results conference call. With me participating in the call are Ajita Rajendra, Chairman and Chief Executive Officer and John Kita, Chief Financial Officer.
Before we begin with Ajita's remarks, I would like to remind you that some of the comments that will be made during this conference call, including answers to your questions, will constitute forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that we have described in this morning’s press release.
In order to provide improved transparency in to the operating results of our business, we provided non-GAAP measures, including adjusted net earnings, adjusted earnings per share and adjusted effective income tax rate for 2017 that exclude the estimate of our total tax expense related to US tax reform. Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and also on our website.
Also, as a courtesy to others in the question queue, please limit yourself to one question and one follow-up per turn. If you have multiple questions, please rejoin the queue.
I will now turn the call over to Ajita, who will begin his remarks on slide 4.
Thank you, Pat and good morning, ladies and gentlemen. Our double digit sales growth in 2017 was driven by continued strong demand for our consumer products in China and positive end markets for our boilers and water heaters in North America. Here are a few highlights. Record sales of $3 billion grew nearly 12%. China sales were up 18% in local currency and up 16% in US dollar terms, reaching over $1 billion in 2017. China water treatment sales grew 35% and air purification sales grew 75% to $45 million.
Our global water treatment sales exceeded 300 million in 2017. We are very proud of the global water treatment platform we have built over the last seven years. Beginning in 2011 with about $35 million of water treatment sales in China, we grew significantly to almost $240 million last year. As we experienced rapid organic water treatment growth in China, we added several bolt-on acquisitions in the US and Europe, launched water treatment products in India and Vietnam and added a significant number of water treatment engineers and technologists to our global engineering center.
As a result of our investments, we project our global water treatment sales to be approximately $400 million in 2018. Record setting adjusted net earnings of $2.17 per share was 17% higher than our earnings per share in 2016. We are delighted to welcome the Hague team to the A. O. Smith family through our acquisition of the US based water softener company in early September. Hague fits squarely in our acquisition strategy to grow our global water treatment platform.
We are excited about the global opportunities Hague’s innovative and high quality products bring us as well as Hague’s experienced water quality dealer network. We continue to review our capital allocation and dedicate a portion of our cash to return to shareholders. We repurchased over 2.5 shares for approximately $139 million. We announced a 29% increase to our dividend earlier this month. The five year compound annual growth rate of our dividend is over 25%. AOS joined the S&P 500 index as of July 2017. We are honored to join this prestigious group of US companies. Our inclusion is a significant milestone in our company's very rich history.
John will now describe our results in more detail, beginning with slide number 5.
Before we discuss the financial results of our fourth quarter and full year, I will provide details of the new tax law impact. Our one-time tax charge in the fourth quarter is estimated to be 82 million or $0.47 per share and is primarily related to the mandatory repatriation tax on undistributed earnings under US tax reform. The one-time charge is expected to be paid over eight years. We project our effective income tax rate in 2018 to be between 22% and 22.5%.
We expect to repatriate approximately 200 million in the first half of 2018 and use the proceeds to repay floating rate debt. Our capital allocation strategy will remain focused on three pillars. One, to support our growth with capital spending; two, to pursue acquisitions, which expand our core water heating and water treating platforms globally as well as expand our product lines, primarily in China; and three, to return cash to shareholders. We will continue to review opportunities within the three pillars and discuss with our board.
Sales for the year of 3 billion were 12% higher than the previous year. Adjusted net earnings of 378 million increased 16% from 2016. Adjusted earnings per share of $2.17 increased 17% compared with 2016. Sales in our North America segment of 1.9 billion increased 9% compared with 2016. The increase in sales was primarily due to higher volumes of water heaters and boilers and pricing actions related to steel cost increases.
North America water treatment sales comprised of recently acquired Hague as well as a full year of Aquasana incrementally added approximately 40 million to our North America segment sales. Rest of World segment sales of 1.1 billion increased 16% compared with 2016. China’s sales increased nearly 16%, driven by higher demand for our consumer products in the region, led by water treatment and air purification products and pricing actions, primarily due to higher steel and installations costs. The declining Chinese currency unfavorably impacted the translation of China sales by approximately 18 million and sales growth by 200 basis points. Water heater and water treatment sales in India increased approximately 8 million or over 40% in 2017, compared with 2016.
On slide 9, North America segment earnings of 429 million were 11% higher than segment earnings in 2016. The favorable impact from higher sales of water heaters and boilers and the pricing actions in the US were partially offset by higher steel costs. As a result of lower selling, general and administrative expenses as a percentage of sales, 2017 segment margin of 22.5% was higher than the 22.1% generated in 2016. Rest of World earnings of 149 million improved 16% compared with 2016. Higher China sales, including the price increase, were partially offset by higher steel costs, higher fees paid to installers and increased SG&A cost. Expansion of water treatment and air purification product retail outlets in tier 2 and tier 3 cities, higher advertising related to brand building in our newer product categories and higher water treatment product development engineering costs were the primary drivers of higher SG&A in China. Segment margin in 2017 was essentially the same as 2016.
Our corporate expenses were 2 million higher than in 2016, driven by commissioned water treatment market studies in the US and higher engineering costs at our corporate technology center. Our adjusted effective income tax rate in 2017 was 27.4%. The rate was lower than the 29.4% experienced in 2016, primarily due to lower US state income taxes and higher deductions for stock-based compensation. Comparing the lower adjusted effective tax rate with the effective income tax rate of 28% originally projected benefited 2017 result by $0.02 per share.
Sales for the fourth quarter of 769 million were 10% higher than the same quarter in 2016. Adjusted net earnings in the fourth quarter of 105 million increased 26% from the fourth quarter in 2016. Fourth quarter adjusted earnings per share of $0.60 increased 28% compared with the same quarter in 2016. Sales in our North America segment of 461 million increased 6% compared with the fourth quarter of 2016. The increase in sales was primarily due to higher volumes of boilers and commercial water heaters and pricing actions related to steel cost increases. We estimate the commercial water heater industry experienced the pre-buy of approximately 5000 electric units in the fourth quarter due to an anticipated regulatory change in early 2018. North America water treatment sales comprised of Aquasana and recently acquired Hague incrementally added approximately 9 million to our North America segment sales.
Rest of World segment sales of 314 million increased 17% compared with the same quarter in 2016. China sales increased 16% driven by pricing actions primarily due to higher steel and installation costs and higher demand for our consumer products in the region. India sales grew over 40% compared with the same period in 2016.
On slide 13, North America segment earnings of 105 million were 17% higher than segment earnings in the same quarter in 2016. The favorable impact from higher sales of boilers and commercial water heaters, pricing actions in the US and lower ERP costs were partially offset by higher steel and other input costs. These factors drove fourth quarter 2017’s segment margin higher to 22.8% compared with 20.5% last year. Rest of World earnings of 51 million improved 33% compared with the fourth quarter of 2016. Higher China sales, including the price increase were partially offset by higher steel costs and higher fees paid to installers.
Fourth quarter segment margin was 16.2% compared with 14.2% in the same quarter of 2016, due to improved margin for our water treatment products sold in China, lower selling and advertising costs as a percent of sales as well as improved performance in India. Our corporate expenses were higher in the fourth quarter compared with the same period in 2016, primarily due to higher spending at our corporate technology center and higher employee incentive costs. Our adjusted effective income tax rate in the fourth quarter of 2017 was 25.8%. The rate was lower than the 28.9% experienced during the fourth quarter last year, primarily due to lower US state income taxes and higher deductions for stock based compensation.
Cash provided by operations during 2017 was 326 million and similar to our previous projections compared with 447 million provided during 2016. Higher adjusted earnings were more than offset by higher outlays for working capital, primarily due to the higher than anticipated positive cash flows in the fourth quarter of 2016 as well as higher inventories in China to reduce the impact from our -- to our new plant this quarter. Over the two year period from 2016 to 2017, we generated operating cash of 773 million, which compares with 612 million during 2014 and 2015.
Our liquidity position and balance sheet remain strong. Our debt to capital ratio was 20% at the end of 2017. We have cash balances, totaling 820 million located offshore and our net cash position was approximately 410 million at the end of 2017. We completed the acquisition of Hague, a US based water softener company during the third quarter of $45 million -- for $45 million plus a potential earnout of $2 million. Primarily as a result of continued strong cash flow and escalating PBGC premiums, we made a voluntary contribution to our pension plan of $30 million. The after tax impact to our cash flow was approximately 18 million. During 2017, we repurchased approximately 2.5 million shares of common stock for a total of $139 million. Approximately 2.4 million shares remained on our existing repurchase authority at the end of December.
This morning, we announced our 2018 EPS guidance with a range of between $2.50 and $2.58 per share, which includes the benefit related to our lower projected tax rate under US tax reform. The midpoint of our EPS guidance represents a 17% increase in EPS compared with our adjusted 2017 results. Excluding the US Tax Reform benefits from our 2018 guidance midpoint, in other words, using the 2017 adjusted tax rate of 27.4%, our operational performance is expected to improve over 9%. We expect our cash flow from operations in 2018 to be between 475 million and 500 million, which is much higher than the 326 million generated in 2017.
We expect higher earnings and lower outlays for working capital this year, specifically lower inventory levels. We broke ground in 2016 on the construction of a new water treatment and air purification manufacturing facility in China to support the strong growth of these products in China. Our 2018 capital spending plans of approximately 100 million includes 30 million related to completion of this plan. Total costs for the facility, which is expected to begin production in the second quarter will be about 67 million. Our depreciation and amortization expense is expected to be approximately 80 million in 2018.
Our corporate and other expenses are expected to be approximately 49 million in 2018, higher than the 47 million in 2017, partially due to higher projected spending at our corporate R&D center. Our effective income tax rate is expected to be between 22% and 22.5% in 2018, lower than previous year's due to US tax reform. We expect to repurchase our shares in the amount of approximately 135 million in 2018 under a 10b5-1 plan, similar to 2017. We may supplement our 10b5-1 plan with opportunistic share repurchase in 2018. We expect our average diluted outstanding shares in 2018 will be approximately 173 million. We increased our dividend earlier this month by 29%.
I will now turn the call back to Ajita who will summarize our guidance, the business assumptions for 2018 and our growth strategy beginning on slide 17. Ajita?
Thank you, John. We considered several tailwinds and headwinds, as we built our plans for 2018. First, our tailwinds. Both residential and commercial water heater volumes experienced strong growth in 2017. We project US residential water heater industry volumes will increase 250,000 to 300,000 units in 2018 due to continued new construction and expansion of replacement demand. This assumption includes [indiscernible]. Boiler revenues grew 13% in 2017, driven by solid demand for our condensing boilers and new product related market share gains.
We expect our boiler business to grow approximately 10% in 2018. We improved profitability in India in 2017 due to scale in our water heater and water treatment businesses from losing over $9 million in 2016 to $7.5 million loss in 2017. We met our projections despite uncertainty resulting from the implementation of a national goods and services tax and demonetization in the country in 2016. We project India water heaters will approach breakeven in 2018.
Improvements for water heaters and water treatment will continue in 2019 and our total India business will be slightly profitable in 2020. The overall loss in India is expected to be $5 million this year. The headwinds include steel prices are rising and are above year ago levels. At current prices, steel will be a headwind to margins this year compared with last year. Following double digit volume growth in 2017, we project US commercial water heater industry volumes will be down 5000 units this year compared with last year due to the pre-buy of electric units in the fourth quarter of last year.
Our China sales grew 18% in local currency in 2017, easily exceeding $1 billion and surpassing our 15% expected growth rate. China sales in the fourth quarter exceeded our projections by about $20 million. We believe the fourth quarter outperformance was driven by customer orders to qualify for volume incentives as well as larger than expected inventory build by our e-commerce customers for the notable online shopping days in November and December.
We project the fourth quarter outperformance of $20 million will negatively impact our first quarter and full year 2018 China sales. We believe China will grow about 13% for the full year. If you adjust for the $20 million pull in in quarter four, this is a 17% year-over-year growth rate. Our movement of water treatment and air purification manufacturing into our new plant in China will result in a projected incremental cost of approximately $5 million, the majority of which will occur in the first half of 2018.
I’m now moving to slide number 18. Combining the impact of the tailwinds and the headwinds, we are optimistic about our growth and bottom line performance for 2018. We project revenue growth will be between 8.5% and 9.5% for the year and EPS between $2.50 and $2.58. We expect North America segment margin to be between 22% and 22.5% and Rest of World segment margins to expand 30 to 40 basis points over 2017.
Please advance to slide number 19. We have updated the components of our growth model to be consistent with the new disclosure rules, for disaggregation of segment revenue as well as to incorporate recently acquired and organically grown high growth businesses. We combined North America water treatment and India with our strong consumer products business in China and its mid-teens growth rate. This is our high growth category and its sales are 36% of company sales.
We expect sales of North America water treatment composed of Aquasana and Hague product will reach nearly $100 million of revenue this year. India grew over 40% last year and we are enthusiastic about our distribution now being pan India for both water heaters and water treatment. Based on the investments we have already made and are expected to make in the future, we project this high growth portfolio to grow 14% per year.
As many of you know, our Lochinvar branded products are composed of approximately 60% boilers and 40% water heaters. As such, going forward, our growth model will separate the boiler piece of our company with an assumed growth rate which matches its five year revenue CAGR of 10%. Sales of our North America water heater products remained the largest portion of our company sales at 58%, including our Lochinvar branded water heaters. Given the expected new construction required to support household formation and expand the replacement demand, we project water heater revenue growth at a rate of 4%.
The weighted average of our growth model continues to be 8%, which is consistent with our 8.5% to 9.5% growth projections for 2018 and is reasonable for the median term timeframe. Especially in these uncertain economic times, we believe our organic growth potential and are stable defensive replacement market, which represents approximately 85% of North America water heater and boiler volume positively differentiates A. O. Smith from other industrial companies. Coupled with growth and stability, we have a strong balance sheet poised to take advantage of strategic acquisitions that add shareholder value as well as allow us to return cash to shareholders.
This concludes our prepared remarks. And now, we are open for your questions.
[Operator Instructions] Our first question comes from Charlie Brady with SunTrust.
Just I guess on the steel costs, I guess I didn’t hear any mention of additional price increases being put through to offset that. Any particular reason why? I mean you guys have been pretty successful doing that in the past.
Charlie, I think -- this is Ajita. We never comment about future price increases. And in terms of steel prices, it’s tough to predict what's going to happen in the future. As we mentioned in the comments, the steel prices today are a headwind versus what they were last year. And if you look at our past history, over time, we've been able to pass along commodity prices to the marketplace.
Could you quantify what the headwind is today from steel?
Well, I can tell you this. I mean, steel has gone up about 11% since the beginning of December, it’s gone up hot rolled over 11% and cold rolled over about 8%. So it’s been a significant increase.
Yeah. I didn’t hear a whole lot of commentary on US residential water heater sales in the 4Q. Can you just comment a little bit on how that fared?
Sure. I think as you look at, we pretty much hit our numbers that we expected for the total company and we talked about China sales being up almost $20 million where we did miss what’s on the residential side. The industry was up, I think, for the first two months about 90,000 units. We were up minimally during that time period. When we look at the full year though, I think which is important the way we look at it is our market share in the first three months, first three quarters had improved. In the fourth quarter, because we didn't grow as much as the industry, it came back down. But when you adjust for Sears decline, our market share was right on for the year. And I guess the other comment I’ll make is there's really been no change in distribution over the years. So I mean, we're comfortable with our position. But it did not do as well in the fourth quarter as we expected.
Our next question comes from Scott Graham with BMO Capital Markets.
So I want to maybe look at the earnings expectations internally, maybe a little bit more holistically. And I remember way back when you guys had your analyst meeting over a lock in for some time ago, of course, one of the things I think was discussed was an earnings growth number and I don't want to put words in your mouth, but sort of in the 15% to 20% territory. Now that's several years back and the – of large numbers kind of catches up, but at least the last couple of years, we have had 17% earnings growth with the larger numbers being comped and still getting there. And it appears, this year, we’re looking at sort of 8% to 9% base earnings growth. Could you give us an idea on sort of where maybe the push and pull points are to get that level of base business earnings growth higher and could one of them be share repurchases?
Well, I think you're right. We're forecasting a little over 9%. We have exceeded that over the last couple of years. I think there's a couple of factors involved when you look at what -- how 2018 is shaping up is one commercial business has been very strong in the last two or three years, up close to double digits each the last few years. And that certainly is a big contributor to the bottom line. We are actually forecasting it to be down this year because of the pre-buy, so that certainly has an effect on margins. Number two, when you look at, we’ve talked about steel already on the call. I mean, steel has gone up, has gone up almost 10% since December. So that has an effect on margins. And I think the third, again that's why we laid out the headwinds and tailwinds is the new plant coming up in Nanchang, there is some headwind. Now all that being said, we still are comfortable with the 9% and the higher end of our range would be higher than that. So I don't recall the 15% to 20% that was there, but again we look at each year individually.
Right. I guess John though, my question wasn't why it's 9, my question is more, how it can go higher than 9. What lines on the P&L if you will, what regions or product lines maybe could offer some upside and again our share repurchases an acceleration of the same being contemplated.
Well I think we talked about that we're going to buy 135 million plus opportunistically buying more. So theoretically, yes, buying more shares could help the bottom line. I think the upsides we think that exist would be we have higher volumes. Commercial, we're underestimating the volumes we hope. Residential could be stronger. It's been very strong in the last couple of years. And we get some relief from this. So those would be kind of the major areas. China margins, because of the movement of the plant, we're not expecting much growth, but quite frankly, our expectations which we thought about is to grow those margins. So we would hope we’re being conservative on the rest of world margins.
Our next question comes from Mike Halloran with Baird.
So just an easy quick one. The 13% China growth, is that a constant currency number?
We’ve said that’s US dollars and we expect the currency to be flat to maybe RMB, maybe a little bit stronger year-over-year.
And then kind of continuing a little on the rest of world margin side. If I think about the puts and takes here, obviously the price cost side you lined out, the 5 million water treatment you lined out, anything unique that you think is going to happen this year relative to last couple of years on advertising, product expansion build out relative to what's normal or and then any other puts and takes on some of the other growth initiatives there this year that we haven't talked about, whether commercial rental, water purification and how some of those numbers kind of line out as we work through the year as well?
Well, I’ll take a shot at it. Air purification is probably one of the items on the periphery that are important. I mean, we started the year saying we were going to break even and we lost $5 million, so it did not do what our expectations were in ’17. So, our anticipation is we will approach breakeven in ’18. So that's an important qualifier. Bringing the plant up efficiently, so I'll break out the $5 million for you a little that Ajita referenced. The first half of the year, as you can appreciate, we're going to have efficiencies where we have two plants. We're going to be operating two plants for a little bit. We're moving -- we're going to have moved costs, et cetera.
We have higher depreciation because of the investment, we have higher operating cost, because of the electricity, et cetera. Now our expectation for the last half of the year, we start operating much more efficiently than we have in the past. So that kind of offsets the inefficiencies in the first half, leaving us with the depreciation, the moved cost from the operating costs, which as we go into the future, we think we can offset with the efficiencies, et cetera. So that's certainly a qualifier. I will tell you water treatment had a very good fourth quarter. I mean when you look at the margins of rest of world going up, water treatment accounts for about 100 basis points of that.
As we have talked about in the third quarter, they had a difficult third quarter comp, while fourth quarter, they reversed that, had a very good fourth quarter. The thing that we're optimistic about when we look at water treatment for the year, their margins were up about a point to a point and a half compared to prior year. I’ll also tell you, we grow more than the market. We're up almost 35%. The market was up 18% to 19%. So as we've talked about in the past, we know the best products in the marketplace, it’s a high growth market and we are very happy with our position in that market.
So those are some of the puts and takes. Obviously, we need the market to continue to grow in China. We haven’t seen a move from electric to gas. That's just as distribution increases. We used to talk about three years ago that electric was 55%, gas was 45%. I would tell you it's about flit now. That gives us a little bit of a headwind. I mean, we're doing extremely well in the gas. We're gaining share, but it's still not at the level that the electric is. So, the bottom line Mike is, there's a lot of putts and takes.
And then one more specific puts and takes, just in the context of that. When we're thinking about the original guide, when you guys came in to ’17, there was hope to maybe better leverage some of the -- essentially continue to grow your spend on advertising and promotions, et cetera, but get better leverage off of it. Is that the thought going into ’18 at this point?
I would say yes, that is the thought going forward. It might get hidden a little bit by the new plant costs, et cetera, but I think Kevin, I and Ajita have talked, that’s clearly one of the objectives is to start leveraging our SG&A as China gets bigger.
Thank you. Our next question comes from Robert McCarthy with Stifel.
I'm suffering from the flu, so I'm going to try to keep it high level as is my want. First, the capital allocation. Could you just talk about how you're thinking about the state of the balance sheet right now post tax and do some of the changes we've seen in the -- basically where you’re positioned right now, how you see the environment, does that change how you’re looking at M&A or what you pay or where your priorities are there specifically? I think I have a good sense of stack ranking how you're thinking about capital allocation overall, but could you talk a little bit about the M&A environment and challenges, opportunities, how you're thinking about it? Because I think as you’d -- obviously you suffer from a really good problem, which is a strong organic growth outlook overall that you've been seeing, but a pretty high bar for deals. So just talk about what you see about the potential opportunities for M&A in the next couple of years, size, scope, geography, that kind of thing?
I'll start with the capital allocation. I'll give Ajita the easier one on M&A. So I mean, I'll just give you a little, I mean, a little background on our capital allocation strategy that hasn't changed. And if you looked seven years ago, we came out, we started our stock repurchase program and we’ve said we're going to do three things. We're going to invest in ourselves and over the last seven years, we have had capital investments of over $550 million. And much of that has been in the form of capacity. We’ve added India plant, we've added two plants in China, we've added on a lot. That's about 50% more than depreciation over that time period and we expect to continue to invest in ourselves.
Number two, we said return cash to shareholders. Over the last seven years, when we started this cash -- stock buyback program, we've returned over $1 billion to shareholders. That's been in the form of about 400 million in dividends which we've raised our dividend 25% a year for the last five to seven years. But we've also done a fair amount to stock buyback. We’ve bought back over $650 million worth at an average price of less than $30 a share. So we think that's been a good investment.
Third, we've done acquisitions and I'll lead into Ajita. Quite frankly, Ajita and I both say, we haven't done the magnitude of the acquisitions we hoped. Six years ago, we bought Lochinvar, which was a home run. In the last two years, we've built out our platform with respect to the water treatment business and that we've added about, I guess, $80 million of organic sales that cost from $150 million or so. So, it's a long way of saying we've had this approach in place. I don't think this approach changes going forward. Those are still the three pillars and we're comfortable with all three of those pillars and we'll continue to do that.
I don't think tax necessarily changes that. I mean if you look at tax reform, we have about an $82 million cash charge essentially that we're going to pay over eight years and we certainly benefit from tax reform and that we're probably going to generate $30 million to $35 million of cash a year, lower taxes. So it's going to take a while -- two to three years to pay it off, but we certainly in the long term benefit from it and it gives us more firepower.
And I’d just like to reinforce what John said in terms of our overall capital allocation strategy has not changed. It’s essentially looking, number one, investing in ourselves, looking at appropriate strategic acquisition and then returning cash to shareholders appropriately as John mentioned. In looking at the M&A outlook out there, prices are still high. But as you saw when we did Aquasana, we went -- certainly paid the high multiple, but that was a very strategic acquisition.
So we're going to be balancing what we do in terms of return, but at the same time, be very disciplined in terms of the financial goals we've laid out and the acquisitions will be very strategic, which is essentially in heating and cleaning water globally and in China, we expand that judiciously in looking at how we can leverage our brand and distribution in new categories that really fit. So that's been our strategy. I don't see any change in that capital allocation strategy or acquisition strategy going forward other than to reinforce, we will be very disciplined and any acquisitions we do will be very strategic.
And in theory, I guess I'd say that with a lower tax rate, if multiples don’t adjust, it makes it easier for us, domestic ones to hit our ROIC targets.
Our next question comes from Jeff Hammond with KeyBanc Capital Markets.
Just on the 13% growth you explained that the pull forward, but can you walk through how you're thinking about growth for the traditional water heater business versus air versus water or versus the water treatment.
Sure. We would expect that water treatment is -- the market will probably grow 18% to 20%. We would expect water treatment would be 25% and 30%. As I alluded to earlier, we're very comfortable with our position. We would expect air purification to grow 35% to 40%. Again, we’re bringing new products out there, which we think will be beneficial. The electric and gas markets, we would expect quite frankly gas will grow and electric will be somewhat flat because of the transition I talked about earlier. So we'll get some benefit because of the gas position and then some of the other SPUs, like renewable and commercial, we expect to grow nicely. So it's kind of a varied group to get to the 13%.
And then can you just walk through what the loss in India was versus what, I think you said it was going to be approaching breakeven or close to this minus 5 and just the ERP delta, 18 versus 17 as well.
Well, I’ll give you the ERP, the ERP ’17 to ’16 first was about $6 million less. The ERP delta 17 to 18 will be down a couple of million bucks. So we're at that kind of run rate that we're going to be at above 16 million I guess, somewhere around there. Maybe, we need to clarify the India breakeven, but what we said is in 2016, India lost over $9 million. In 2017, it lost $7.5 million or basically hit exactly what our plan was. Even under fairly difficult conditions, given the GST tax changes and the monetization. So we think India had a good year. Our expectation now is next year, sorry this year, ’18, we move from that $7.5 million loss to about $5 million. So, a pickup of about $2.5 million of less loss if you will. And then as we move into ’19, and then ’20, we expect to be breakeven. We actually expect to be profitable. So we this move down from over 9 to 7.5 to 5 to 2 million to 3 million to a positive by 2020.
Our next question comes from David MacGregor with Longbow Research.
I guess I had a couple of questions on sort of the longer term considerations in the business. And for starters, you talked about the rest of world margins being up maybe 30 to 40 basis points in 2018 and I realize there's a lot of moving parts in there. I guess I want to just tap you for your latest thoughts on where this ultimately could get to by 2020 or some point further down the road on a sort of a raw materials normalized basis.
Well I would tell you and we’ve talked about this in the past and Kevin, Agita and I have talked about it, we need to raise rest of world margins. And that’s the objective and quite frankly, the India improvement from 7.5 million to 0 by 2020 improves margin by 60 to 70 basis points, right there. But in addition, China obviously is the largest component there. The objective is to raise margins there. We hope to do it this year, but again, we have that implant tailwind, et cetera, but we hope to do it this year. So I mean I would hope that that 13.75 that we're forecasting this year is conservative, but we'll see. But long term, the objective is definitely to increase rest of world margins.
It just seems like there's a lot of other things going on in that segment beyond India and China, you’ve got the [indiscernible] Turkey, you’ve got China water treatment. It just seems like a lot of those things, if not all of them are currently a drag on rest of world margins. And so I guess –
And we would agree with that. So you take the air purification loss $5 million, the boiler loss $6 million, or $7 million, the commercial water treatment loss, $3 million. So I would agree with you. Our objective is if we can move dollars to breakeven, again that's -- I think what I just, $15 million. That's 1.5% right there based on this year, not where the sales are two years from now.
And I think, that's a great point, because we are probably always going to have some businesses incubating where we are investing for future growth. It so happens that at this particular point, in the last year, couple of years, we've had more than a normal run rate of businesses intubating. But all of these, as you look at them individually, the ones we mentioned, clearly, are investments for longer term growth, longer term profitable growth. So the opportunity to continue to leverage that reservoirs margin is clearly there.
Second question again, just kind of a longer term question, but as we talk to distributors, it's pretty clear that within the commercial world, tankless is making some pretty good progress and you've got product in there that you rely on is disproportionately large in terms of its margin contribution lifecycle. And I’m just wondering to what extent you're feeling the pressure in those sort of higher margin contributing categories for products from tankless and ultimately I guess longer term question is, where does A. O. Smith go with regard to tankless, what's the strategy there longer term and do we see a greater commitment to that format over the next two to three years?
There's no doubt we think tankless increase. It’s been increasing kind of at double digits. We would still be of the opinion that the majority of it is going to new construction and going into retrofit, et cetera, residential. There is probably some going into commercial, but we don't think it’s a significant amount. And so, but Ajita can talk about our position long term, but it’s clearly growing, but again, it’s still 700,000 units on an industry that was 9.2 million. So we're certainly watching it and we participate in it. We have a very attractive product offering in it, but you're right. We have a lower market share there than we do in the other businesses.
Yeah. And I think if you look at it from a global perspective in response to your question about our commitment to the technology, clearly, we are very committed to the technology. In fact, if you look at our market in China, we are the leaders in our market in China. And we manufacture everything that we sell and we compete with the same players who are leading in the US. It's just that we got a later start in the US market. Now, in the US market, we source our product from Japan. In China, we make it ourselves and just to put in perspective in terms of numbers of units, John mentioned that the total market here was close to 700,000 units. We sell about 2 million units that we make in China as the leaders in the market.
[Operator Instructions] We do have a follow up from Robert McCarthy with Stifel.
I guess conversely, looking at in terms of capital allocation and M&A, I mean you've done a great job, the returns have been strong, you've moved to the S&P 500, the company is a lot bigger, you’ve got a lot of opportunity in China. Part of the attraction is obviously you can definitely leverage your channel in China and bring in a lot of products either through licensing or otherwise if you did some form of JV and I've asked this question of you before, but is that something you're looking at and the related question is, let's not talk about gossip or what you'd be willing to do, but would it make sense over the longer term for you strategically to be part of a larger company and what could it bring in terms of investment, brand, things like that that perhaps you could even execute an even faster, larger growth strategy in China, because you’ve just got a very valuable channel you've been developing there. Not like for your core products, but for these add-ons. Just any thoughts there.
First of all, I’m not going to speculate in terms of the future, because obviously that doesn’t get us anywhere. But from a strategic perspective, in terms of us being an independent company, we will always be an independent company. Okay. There is no, I mean, in your thoughts in terms of, there is no -- we are not looking at something that you mentioned in terms of combination and things like that. If we're looking at, can we license products, et cetera, everything is open that’s strategic in terms of, if it's the right product that fits our brand name for us to leverage it, we can source that product in many ways. We can do a greenfield, we can do an acquisition, we can license our brand to somebody else.
We can buy them. So we've looked at all of those types of ways to say, what's the right pace to grow. And as we look at to grow, whenever we get into a new category, it takes $40 million, $50 million to break even because this is a branded consumer products business. So the advertising costs, the promotion costs, the entry costs into retail et cetera are very high. So it's that balance of the right pace to be incubating and growing businesses at the same time, growing our margins and as the businesses have been in for a long time, mature like our electric water heater business. So it’s that balance that we look at all the time, and we leverage to keep the 15% growth rate that we’ve been guiding to for the long-term, while also increasing our margin.
And I'm showing no further questions. I would now like to turn the call back to Ms. Patricia Ackerman for any further remarks.
Thank you all for joining us this morning. Please take note that we will participate in the Boenning & Scattergood Conference on March 8 in London. Have a wonderful day.
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