Investment research report for WSO

Table of Contents

Executive Summary
Valuation Analysis
Industry and Competitors Analysis
Financial Analysis
Earnings Call Multi-Year Analysis
Financial Statements Multi Year
Insider Trading Analysis
Management Compensation Benchmark Analysis
Proxy Statement Analysis
News Analysis
Technical Indicators Analysis
Financial Statements Annual
Financial Statements Quarterly
Earnings Call Analysis

Executive Summary

Company Overview

Watsco, Inc. is the largest distributor of air conditioning, heating, and refrigeration equipment and related parts and supplies in the HVAC/R distribution industry. The company operates across the United States, Canada, Mexico, and Puerto Rico, serving over 120,000 contractors and dealers through its extensive distribution network.

Competitive Advantages

  1. Market Leadership: Watsco’s dominant market position, scale, and geographic reach provide significant competitive advantages, including pricing power and operational efficiencies.
  2. Focus on Replacement Market: Approximately 85-90% of Watsco’s sales are derived from the stable and recurring residential replacement HVAC market, offering a consistent revenue stream as aging systems need to be replaced.
  3. Technology and Innovation: The company has invested heavily in technology, e-commerce capabilities, and data analytics, enhancing customer experience, operational efficiency, and driving market share gains.

Financial Strength and Growth Prospects

  1. Consistent Revenue and Profit Growth: Watsco has demonstrated a strong track record of consistent revenue and profit growth over the past decades, driven by organic growth, strategic acquisitions, and market share gains.
  2. Robust Financial Position: The company maintains a healthy balance sheet, robust cash flows, and manageable debt levels, providing financial flexibility to invest in growth opportunities and return capital to shareholders.
  3. Shareholder-Friendly Policies: Watsco has a history of paying consistent dividends and repurchasing shares, demonstrating a commitment to returning capital to shareholders.
  4. Sustainability Tailwinds: The transition towards higher-efficiency HVAC systems, supported by regulatory changes and incentives, presents a significant growth opportunity for Watsco.

Investment Thesis

Watsco’s market leadership, focus on the stable replacement market, diversified supplier relationships, successful acquisition strategy, financial strength, shareholder-friendly policies, and sustainability positioning make it an attractive long-term investment opportunity in the HVAC distribution industry.

Back to Table of Contents

Valuation Analysis

PE Ratio

The PE ratio for the company WSO is as follows:
– Low: 18.931708654833287
– Base: 25.706787272947672
– High: 32.48186589106206

PB Ratio

The PB ratio for the company WSO is as follows:
– Low: 3.8679913568711024
– Base: 5.2477970777222405
– High: 6.6276027985733785

Growth Rates

The growth rates for the company WSO are as follows:
– EPS Growth:
– Low: 9.73%
– Medium: 14.48%
– High: 17.93%
– DPS Growth:
– Low: 13.48%
– Medium: 14.80%
– High: 16.01%

Unable to provide price targets since this company’s financials are highly unstable. We recommend not to hold this stock in your portfolio.

Back to Table of Contents

Industry and Competitors Analysis

Watsco, Inc. (WSO) and its Competitors

Based on the information provided, Watsco, Inc. (WSO) operates in the industrial distribution industry, distributing air conditioning, heating, refrigeration equipment, and related parts and supplies. Its main competitors appear to be other major industrial distributors such as:

  1. Fastenal Company (FAST): A large distributor of industrial and construction supplies, including fasteners, tools, safety products, and more.

  2. SiteOne Landscape Supply, Inc. (SITE): A distributor of landscape supplies, irrigation systems, nursery goods, and related products.

  3. Ferguson plc (FERG): A distributor of plumbing and heating products, as well as building materials and related services.

  4. W.W. Grainger, Inc. (GWW): A broad-line distributor of maintenance, repair, and operating (MRO) products and services.

  5. Pool Corporation (POOL): A distributor of swimming pool supplies, equipment, and related leisure products.

  6. MSC Industrial Direct Co., Inc. (MSM): A distributor of metalworking and MRO products and services.

  7. Applied Industrial Technologies, Inc. (AIT): A distributor of industrial motion, power, control, and automation technology solutions.

  8. Core & Main, Inc. (CNM): A distributor of water, wastewater, storm drainage, and fire protection products and services.

  9. DXP Enterprises, Inc. (DXPE): A distributor of MRO products, equipment, and services, primarily serving the energy and industrial sectors.

In terms of competitive positioning, Watsco appears to be a significant player in the HVAC and refrigeration equipment distribution market, with a strong presence across the United States, Canada, Mexico, and Puerto Rico. Its focus on air conditioning, heating, and refrigeration products and services differentiates it from some of the broader industrial distributors like Grainger and MSC Industrial Direct. However, it faces competition from other specialized HVAC distributors and may need to compete on factors such as product range, pricing, and customer service.

Back to Table of Contents

Chart of Competitors

"Chart of Competitors"

Back to Table of Contents

Financial Analysis

Financial Strength

The company has maintained a healthy current ratio between 2.5-3.5 over the years, indicating good liquidity position. The debt/equity ratio has been relatively low, mostly below 0.35, suggesting a conservative capital structure. Interest coverage ratios are very high, implying the company can comfortably service its debt obligations.

Potential for Growth

Revenue growth has been volatile, with some quarters showing strong growth (e.g. Q2 2022 at 40%) and others negative growth. The 3-year revenue growth per share has been positive but modest, around 30-50% range in recent years. Analyst estimates project revenue growth of around 7-9% annually over the next few years.

Competitive Advantage

Gross profit margins have been relatively stable around 25-27%, indicating pricing power. The company seems to have a strong market position as a distributor of HVAC equipment and supplies.

Quality of Management

Return on equity and assets have been healthy, mostly in the 5-10% range, suggesting efficient use of capital. Operating cash flow growth has been volatile but generally positive over 3-year periods.

Shareholder Friendliness

The company pays a modest dividend, with a payout ratio typically below 1. Share repurchases do not seem to be a major use of cash based on the data provided.

Valuation

P/E ratios have varied widely from 12x to over 50x, making valuation assessment difficult. Price/Book ratios have mostly been in the 4-7x range in recent years. Analyst EPS estimates for the next few years suggest a forward P/E around 15x based on the current stock price.

Overall, Watsco appears to be a financially solid company with decent growth prospects in the HVAC distribution industry. However, growth has been uneven, and valuation multiples have fluctuated significantly over time. Investors would need to assess whether the current valuation compensates for the growth opportunities and risks facing the company.

Back to Table of Contents

Chart of Key Per Share Metrics

"Chart of Key Per Share Metrics"

Back to Table of Contents

Chart of Absolute Metrics

"Chart of Absolute Metrics"

Back to Table of Contents

Earnings Call Multi-Year Analysis

Competitive Advantages and Market Share Gains

Watsco has strong competitive advantages stemming from its scale, technology investments, broad product portfolio, and focus on high-growth Sunbelt markets. These advantages are allowing it to gain market share and drive margin expansion.

Industry Tailwinds and OEM Partnerships

The company is well-positioned to benefit from several long-term industry tailwinds, including regulatory changes around efficiency standards and refrigerants, electrification trends favoring heat pumps, and incentives promoting higher-efficiency systems. Its close OEM partnerships are an asset in navigating these transitions.

Technology Investments and Pricing Power

Watsco’s investments in technology, e-commerce, and pricing optimization tools are paying off in terms of higher customer engagement, stickiness, and pricing power. However, there is still room to drive further adoption across the contractor base.

Margin Expansion and Sustainability

Gross margins have expanded significantly, aided by mix shifts and effective pricing management. While some moderation is expected, the company sees a path toward sustaining elevated margins through its initiatives.

Operational Efficiency Initiatives

Inventory management, productivity improvements, and cost controls remain areas of focus, especially as supply chains normalize, to drive operating leverage.

Financial Strength and Growth Investments

The company maintains a strong balance sheet and is committed to investing for long-term growth, both organically through technology/product initiatives and via strategic acquisitions of distributors.

While mindful of economic cycles, management seems confident in Watsco’s ability to navigate near-term challenges and capitalize on its advantages to drive profitable growth over the long run.

In summary, Watsco appears well-positioned strategically, with competitive strengths, operational excellence initiatives, and exposure to positive long-term industry trends – factors that should benefit the patient, long-term investor.

Back to Table of Contents

Financial Statements Multi Year

Revenue and Profit Growth

Watsco has demonstrated consistent long-term revenue and profit growth, expanding from $641 million in revenue in 1989 to over $7 billion in recent years. This indicates a successful growth strategy over decades.

Market Leadership

Watsco is the largest HVAC equipment distributor in North America with an extensive network, providing a strong competitive advantage and pricing power.

Stable Replacement Market Focus

A majority (85-90%) of Watsco’s sales come from the residential replacement HVAC market, which offers stable and recurring demand as systems age and need replacement.

Diversified Supplier Relationships

Watsco has strong, diversified relationships with major HVAC manufacturers, mitigating supplier risk.

Acquisition Strategy

Watsco has successfully executed an acquisition strategy, integrating 66 distributors since 1989 to drive growth and market share gains.

Financial Strength

The company maintains a healthy balance sheet, robust cash flows, and manageable debt levels, providing financial flexibility.

Shareholder Returns

Watsco has a track record of paying consistent dividends and repurchasing shares, demonstrating commitment to shareholder returns.

Innovation Focus

Investments in technology, e-commerce, and data analytics position Watsco well for future growth and efficiency gains.

Sustainability Tailwinds

Watsco benefits from the transition to higher-efficiency HVAC systems, supported by regulatory changes like the Inflation Reduction Act.

Overall, Watsco’s market leadership, focus on the stable replacement market, diversified suppliers, acquisition strategy, financial strength, shareholder returns, and sustainability positioning make it an attractive long-term investment opportunity.

Back to Table of Contents

Insider Trading Analysis

Long-Term Patterns

The CEO (NAHMAD ALBERT H) and the CFO (MENENDEZ ANA M) have consistently held and acquired significant amounts of Watsco stock over the years, indicating their long-term commitment and confidence in the company. Other key insiders like LOGAN BARRY S (Director) and Nahmad Aaron J (President) have also maintained large ownership stakes in the company. There have been regular stock option grants and awards to executives and directors, aligning their interests with shareholders. Insider selling has been relatively limited, with most transactions involving stock option exercises and share transfers.

Recent Patterns

In the most recent 2 years, the CEO and CFO have continued to receive stock awards, further increasing their ownership. There have been a few instances of insider selling, but the amounts have been modest compared to their overall holdings. Other insiders like LOGAN BARRY S, Nahmad Aaron J, and MENENDEZ ANA M have also received stock awards and made some minor transactions.

Implications

The consistent and substantial insider ownership, along with the limited selling, suggests that the company’s leadership has a strong long-term outlook and confidence in Watsco’s future prospects. The stock-based compensation aligns the interests of executives and directors with those of shareholders, which is generally viewed positively by long-term investors. The recent insider trading activity does not indicate any major concerns or changes in the company’s outlook from the perspective of its key decision-makers.

Overall, the long-term and recent insider trading patterns at Watsco appear to be positive and supportive of the company’s long-term growth and shareholder value creation.

Back to Table of Contents

Management Compensation Benchmark Analysis

Alignment with long-term shareholder value

The executives at WSO appear to have a significant portion of their total compensation tied to stock awards, which aligns their interests with creating long-term shareholder value. The average percentage of base salary out of total compensation for WSO executives is 40.61%, which is higher than the average for the other companies analyzed (FAST at 38.58%, SITE at 32.13%, GWW at 32.53%, and POOL at 29.18%).

Emphasis on equity-based compensation

A substantial portion of the total compensation for WSO executives comes from stock awards, ranging from around 50% to over 90% of total compensation in some cases. This suggests the company places a strong emphasis on equity-based incentives to drive long-term performance.

Consistent compensation structure

The compensation structure for WSO executives appears to be relatively consistent over the years, with a similar mix of salary, bonus, and stock awards. This consistency in the compensation approach may indicate a well-established and thoughtful approach to aligning executive incentives with shareholder interests.

Compensation of the CEO and President

The CEO (Albert H. Nahmad) and President (Aaron J. Nahmad) of WSO receive the highest total compensation among the reported executives. However, the base salary portion of their total compensation is relatively low, at around 5-6%, suggesting a strong emphasis on equity-based incentives.

In comparison, the other companies analyzed (FAST, SITE, GWW, and POOL) also demonstrate a focus on aligning executive compensation with long-term shareholder value, but the specific structures and percentages vary. Overall, the executive compensation at WSO appears to be well-designed to incentivize long-term performance and value creation for shareholders.

Back to Table of Contents

Proxy Statement Analysis

Executive Compensation

The executive compensation program at Watsco appears to be designed with long-term incentives in mind. The proxy statement indicates that a significant portion of the CEO’s and other named executive officers’ compensation is tied to performance-based equity awards that vest over multiple years. This suggests the company is aiming to align the interests of its executives with those of long-term shareholders.

However, without reviewing the full details of the compensation plans and metrics, it is difficult to definitively conclude whether the incentives are properly structured and implemented to achieve that alignment. Factors such as the specific performance targets, the rigor of those targets, and the overall mix of short-term and long-term incentives would need to be analyzed in depth to make a more informed assessment.

Shareholder Alignment

The proxy statement also provides information on Watsco’s stock ownership guidelines for executives, which require the CEO and other named executive officers to maintain a significant equity stake in the company. This is a positive sign, as it helps ensure that the executives’ personal financial interests are closely tied to the long-term performance of the business and the creation of shareholder value.

Recommendation

For a long-term investor, a careful review of Watsco’s proxy statements and other public filings would be necessary to fully understand and evaluate the executive compensation program. This analysis should consider the specific details of the compensation plans, the rigor of the performance targets, and the overall alignment between executive incentives and shareholder interests. Only then can a more definitive assessment be made regarding the effectiveness of Watsco’s approach to executive compensation.

Back to Table of Contents

News Analysis

Positive Factors

  1. Strong financial performance: Watsco has consistently reported record sales, operating profits, net income, and cash flows in recent quarters, indicating robust business growth.

  2. Dividend growth: The company has raised its dividend for several consecutive years, with the latest increase being a 10% hike in 2024. This demonstrates a commitment to returning cash to shareholders.

  3. Market share gains: Watsco has been gaining market share in the HVAC/R distribution industry, even during periods of soft market demand, suggesting competitive advantages.

  4. Technological innovations: The company has invested in digital technologies to enhance its distribution capabilities and customer experience, which could drive further growth.

  5. Acquisitions: Watsco has been actively acquiring companies to expand its geographic footprint and product offerings, fueling growth through a “buy and build” strategy.

Potential Concerns

  1. Housing market cyclicality: As a distributor of HVAC/R products, Watsco’s performance is tied to the residential and commercial construction markets, which can be cyclical.

  2. Inflationary pressures: Rising costs for materials, labor, and transportation could impact profitability if the company is unable to pass on these increases to customers.

  3. Valuation: Some analysts have raised concerns about Watsco’s valuation being stretched, especially during periods of economic uncertainty.

  4. Supply chain disruptions: Potential disruptions in the supply chain for HVAC/R equipment and parts could impact the company’s ability to meet customer demand.

Overall, Watsco appears to be a well-managed company with a strong track record of growth, profitability, and shareholder returns. However, investors should monitor the housing market conditions, inflationary pressures, and the company’s ability to maintain its competitive advantages in the face of potential challenges.

Back to Table of Contents

Technical Indicators Analysis

Next Week Trading

The recent price action and technical indicators suggest a potential short-term pullback or consolidation in the next week. The 10-day RSI is in overbought territory, indicating the stock may be due for a correction. However, the 20-day TEMA and 20-day SMA remain in an uptrend, suggesting the overall bullish momentum is still intact.

Resistance and Support Levels

The key resistance levels to watch are around $490-$495, which correspond to the recent highs. The 50-day and 200-day SMAs around $457 and $408 respectively could provide support if the stock pulls back. The 14-day ADX is above 25, indicating a strong trend, so these support levels may hold in the short-term.

Short Term Investor

Short-term investors may want to consider taking some profits around the resistance levels mentioned above, as the stock appears overbought in the near-term. However, the overall trend remains bullish, so any pullbacks could present buying opportunities for the short-term trader.

Long Term Investor

For long-term investors, the technical picture remains quite positive. The 20-day, 50-day, and 200-day SMAs are all in an uptrend, and the 14-day ADX indicates a strong trend. The long-term support levels around $408 (200-day SMA) provide a good entry point for investors with a longer time horizon.

Overall, the technical indicators suggest a strong uptrend for this company, with the potential for some short-term consolidation or pullback before the uptrend resumes. Long-term investors may want to hold or add to their positions, while short-term traders should be mindful of the overbought conditions and resistance levels.

Back to Table of Contents

Chart of Valuation History

"Chart of Valuation History"

Back to Table of Contents

Financial Statements Annual

Financial Statements Annual 2024 Q2

Strong Financial Performance

Watsco reported robust revenue growth of $7.28 billion in 2023, up from $6.51 billion in 2022. Gross profit margin remained healthy at 26.9%, indicating the company’s ability to maintain pricing power. Operating income grew to $771 million, representing a strong operating margin of 10.6%. Net income increased to $536 million, translating to earnings per share of $13.72. The company generated substantial free cash flow of $526 million, providing financial flexibility.

Efficient Capital Allocation

Watsco has a strong balance sheet with $210 million in cash and cash equivalents and manageable debt levels, with a net debt position of $195 million. The company continues to invest in its business, with $35 million in capital expenditures, while also returning capital to shareholders through $383 million in dividends paid. Watsco’s disciplined acquisition strategy has allowed it to expand its geographic footprint and product offerings, further strengthening its market leadership position.

Focus on Sustainability and Energy Efficiency

Watsco plays a crucial role in the transition to more energy-efficient HVAC systems, with the majority of its sales being replacement units that meet higher efficiency standards. The company estimates that it has averted 192 million metric tons of CO2 emissions from January 2020 to December 2023 through the sale of high-efficiency HVAC systems. The recent passage of the Inflation Reduction Act is expected to further drive demand for high-efficiency HVAC equipment, providing a tailwind for Watsco’s business.

Competitive Advantages and Growth Opportunities

Watsco’s extensive distribution network, strong supplier relationships, and focus on customer service provide a competitive edge in the highly fragmented HVAC distribution industry. The company’s strategy of acquiring and integrating market-leading distributors has allowed it to expand its geographic reach and product offerings, positioning it for continued growth. The residential replacement market, which accounts for the majority of Watsco’s sales, is expected to remain a stable and growing segment due to the aging installed base of HVAC systems.

Overall, Watsco’s financial performance, efficient capital allocation, focus on sustainability, and competitive advantages position the company well for long-term growth and value creation for shareholders.

Financial Statements Annual 2023 Q2

Consistent Revenue and Profit Growth

Watsco has grown its revenues from $641 million in 1989 to $7.27 billion in 2022, demonstrating a strong track record of consistent revenue growth over the long-term. Similarly, the company has grown its net income from $601 million in 2022, indicating steady profitability.

Dominant Market Position

Watsco is the largest distributor of HVAC equipment, parts and supplies in North America, operating from 673 locations across 42 U.S. states, Canada, Mexico and Puerto Rico. This extensive distribution network and market leadership position provide a competitive advantage.

Diversified Supplier Relationships

Watsco has strong relationships with major HVAC equipment manufacturers like Carrier, Rheem, Daikin and others, representing 84% of its total purchases. This supplier diversification helps mitigate risks from any single supplier disruption.

Healthy Financials

The company maintains a strong balance sheet with $147.5 million in cash and cash equivalents, $1.89 billion in stockholders’ equity and a manageable debt load of $379 million. The robust free cash flow of $538 million in 2022 provides financial flexibility.

Focus on Replacement Demand

A majority of Watsco’s sales (estimated 85-90%) are in the higher-margin residential replacement market, which provides stable and recurring revenue as aging HVAC systems need to be replaced.

Commitment to Innovation and Technology

Watsco has invested significantly in developing digital tools, e-commerce capabilities and data analytics to enhance the customer experience and operational efficiency, positioning the company well for the future.

Shareholder-Friendly Policies

The company has a history of paying regular cash dividends to shareholders and has an active share repurchase program, demonstrating a commitment to returning capital to investors.

Overall, Watsco’s dominant market position, diversified supplier relationships, healthy financials, focus on the replacement market, and investments in innovation make it an attractive long-term investment opportunity for investors.

Financial Statements Annual 2022 Q2

Consistent Revenue and Profit Growth

Watsco has grown its revenues from $641 million in 1989 to $6.28 billion in 2021, demonstrating a strong track record of consistent revenue growth over the long-term. Similarly, the company has grown its net income from $418.9 million in 2021, indicating steady profitability.

Dominant Market Position

Watsco is the largest distributor of HVAC equipment, parts and supplies in North America, serving over 120,000 active contractors and dealers. This dominant market position provides scale advantages and pricing power.

Diversified Supplier Relationships

Watsco has significant relationships with major HVAC equipment manufacturers like Carrier, Rheem, Goodman, Trane and Lennox, providing access to a diverse product portfolio and stable supplier base.

Focus on Replacement Market

The majority of Watsco’s sales (estimated 85-90%) are to the residential HVAC replacement market, which is a large, stable and growing market as aging systems need to be replaced with more energy-efficient models.

Acquisition-Driven Growth Strategy

Watsco has successfully acquired 66 HVAC distribution businesses since 1989, integrating them into its operations and driving further growth and market share gains.

Strong Cash Flow and Balance Sheet

Watsco generates robust operating cash flow ($349.6 million in 2021) and maintains a healthy balance sheet with $118.3 million in cash and $360.5 million in total debt, providing financial flexibility.

Shareholder-Friendly Capital Allocation

Watsco has a history of paying consistent dividends to shareholders and has authorized the repurchase of up to 7.5 million shares, demonstrating a commitment to returning capital to shareholders.

Overall, Watsco’s dominant market position, diversified supplier relationships, focus on the stable replacement HVAC market, successful acquisition strategy, strong cash flows and shareholder-friendly capital allocation make it an attractive long-term investment opportunity.

Back to Table of Contents

Financial Statements Quarterly

Financial Statements Quarterly 2024 Q2

Revenue Growth

Revenues increased by 1% year-over-year, driven by $51 million from new locations acquired and $11 million from other locations opened in the past 12 months, partially offset by $8 million from locations closed.

Gross Margin Decline

Gross profit margin declined by 140 basis points to 27.5%, primarily due to the impact of pricing and sales mix for HVAC equipment.

Expense Growth

Selling, general and administrative expenses increased by 8%, primarily due to newly acquired locations. On a same-store basis, these expenses increased by 4% as a percentage of sales.

Profitability

Net income attributable to Watsco Inc. decreased by 21% compared to the prior year quarter, driven by lower gross profit and higher expenses, partially offset by higher revenues, reduced income taxes, and lower net income attributable to the noncontrolling interest.

Cash Flow and Liquidity

Operating cash flow increased significantly, up $151 million year-over-year, primarily due to timing of vendor payments. The company had $278 million in cash and cash equivalents and $200 million in short-term investments at the end of the quarter.

Acquisitions

The company completed three acquisitions during the past 12 months, adding 18 locations and approximately $330 million in annualized revenues.

Capital Allocation

The company paid $97 million in dividends and generated $282 million in net proceeds from its at-the-market equity offering program, which was primarily used for investments and debt repayment.

Sustainability Focus

The company highlighted its role in helping customers reduce their carbon footprints through the sale of higher-efficiency HVAC systems, which it estimates have averted 201 million metric tons of CO2 emissions since 2020.

Financial Statements Quarterly 2024 Q1

Revenue Growth

Watsco’s revenues increased 4% in Q3 2023 compared to Q3 2022, driven by $179 million from new acquired locations and $17 million from other new locations opened in the past 12 months. However, on a same-store basis, revenues increased 4% in Q3 2023.

Gross Margin Decline

Gross profit margin declined 40 basis points in Q3 2023 compared to Q3 2022, primarily due to a stronger sales growth of lower-margin HVAC equipment versus higher-margin other HVAC products.

Operational Efficiency

Selling, general and administrative expenses decreased 1% in Q3 2023 compared to Q3 2022, and on a same-store basis, decreased 2%, indicating improved operating efficiencies.

Profitability

Net income attributable to Watsco Inc. increased 8% in Q3 2023 compared to Q3 2022, driven by higher revenues, gross profit, and other income, partially offset by higher interest expense and income taxes.

Liquidity and Capital Resources

Working capital increased to $1.84 billion at September 30, 2023, from $1.39 billion at December 31, 2022, due to higher inventory, accounts receivable, and the classification of borrowings under the revolving credit agreement as long-term. The company has ample liquidity from operating cash flows, cash on hand, and availability under its $600 million revolving credit facility.

Acquisitions

Watsco acquired two HVAC distributors, Capitol District Supply Co. Inc. and Gateway Supply Company Inc., during the first nine months of 2023, expanding its geographic footprint and product offerings.

Dividend Payments

Watsco continued to pay regular quarterly cash dividends of $0.245 per share on both Common and Class B common stock during the first nine months of 2023.

Overall, Watsco demonstrated solid financial performance in Q3 2023, with revenue growth, operational efficiency, and profitability improvements, while maintaining a strong liquidity position to support its growth strategy, including strategic acquisitions.

Financial Statements Quarterly 2023 Q4

Revenues

Revenues decreased 6% in Q2 2023 compared to Q2 2022, primarily due to supply chain disruptions and inventory availability issues. On a same-store basis, revenues decreased 6% in Q2 2023 and 3% in the first half of 2023 compared to the prior year periods. The decrease in revenues was partially offset by $36 million from new locations acquired and $31 million from other locations opened in the past 12 months.

Gross Profit

Gross profit margin improved 20 basis points in Q2 2023 compared to Q2 2022, primarily due to the timing of price increases. Gross profit margin declined 20 basis points in the first half of 2023 compared to the prior year period, primarily due to less beneficial pricing actions by HVAC equipment suppliers.

Expenses

Selling, general and administrative (SG&A) expenses decreased 3% in Q2 2023 and 1% in the first half of 2023 compared to the prior year periods, primarily due to lower variable costs in line with the revenue decline. Interest expense increased 208% in Q2 2023 and 142% in the first half of 2023 due to higher effective interest rates and higher average borrowings under the revolving credit facility.

Profitability

Net income attributable to Watsco Inc. decreased 10% in Q2 2023 and 8% in the first half of 2023 compared to the prior year periods, primarily due to lower revenues, gross profit, and higher interest expense, partially offset by lower SG&A expenses, higher other income, and lower income taxes.

Cash Flows and Liquidity

Working capital increased to $1,926.6 million at June 30, 2023, from $1,392.2 million at December 31, 2022, primarily due to higher inventory and accounts receivable. The company entered into a new $600 million, 5-year revolving credit agreement in March 2023, which replaced the prior $560 million facility. The company issued and sold 45,000 shares of common stock under its ATM program during Q2 2023 for net proceeds of $15.2 million.

Overall, the financial statements indicate that Watsco faced some challenges in the first half of 2023 due to supply chain disruptions and inventory availability issues, which impacted revenues and profitability. However, the company continues to maintain a strong liquidity position and has taken steps to refinance its debt and raise additional capital through its ATM program.

Financial Statements Quarterly 2023 Q3

Revenue Growth

Watsco reported a 2% increase in revenues for the quarter, driven by a combination of new locations, recent acquisitions, and same-store sales growth. This indicates the company is maintaining its market position and expanding its footprint.

Gross Margin Pressure

Gross profit margin declined by 70 basis points compared to the prior year quarter, primarily due to lower pricing benefits from HVAC equipment suppliers. This suggests Watsco is facing some margin pressure, likely due to inflationary and supply chain challenges.

Operational Efficiency

Selling, general, and administrative expenses increased by 1% on a same-store basis, while decreasing as a percentage of revenues. This implies Watsco is maintaining operational efficiency and leveraging its fixed cost base as revenues grow.

Strong Cash Flow and Liquidity

Watsco generated negative operating cash flow of $41.8 million, which is typical for the seasonally weaker first quarter. However, the company has a strong balance sheet with $162.5 million in cash and cash equivalents and access to a $600 million revolving credit facility, providing ample liquidity to fund operations, investments, and shareholder returns.

Shareholder Returns

Watsco paid $95.4 million in dividends during the quarter, demonstrating its commitment to returning capital to shareholders. The company also has a $112.9 million remaining authorization under its share repurchase program, which it may utilize to further enhance shareholder value.

Overall, Watsco’s Q2 2023 results show the company is navigating the current economic and supply chain challenges relatively well, maintaining its market leadership, operational efficiency, and financial flexibility. The long-term investor may view Watsco as a resilient and shareholder-friendly HVAC distribution business.

Back to Table of Contents

Earnings Call Analysis

Earnings Call Analysis 2024 Q2

Watsco is well-positioned for long-term growth:

Watsco has a strong balance sheet and cash flow, which allows them to fund growth opportunities. They have a broad product portfolio and a strong brand presence, enabling them to serve contractors in any market environment. The company is also investing in technology to maintain a competitive advantage. The HVAC industry remains highly fragmented, providing M&A opportunities for Watsco to expand its scale.

Near-term market conditions are mixed:

Residential equipment demand remains soft, but commercial markets are growing. The transition to new A2L refrigerants could create some inventory challenges in the short term. Pricing actions from OEMs may face some resistance from contractors passing along increases to customers.

Management is focused on operational efficiency:

Watsco is implementing actions to improve SG&A and productivity across the organization. The management team is cautious about speculating on inventory positions related to the refrigerant transition.

Regulatory changes and industry fundamentals provide long-term tailwinds:

The potential benefits from the Inflation Reduction Act incentives, though the timing and magnitude remain uncertain, could be beneficial for Watsco. The shift to higher efficiency and heat pump products aligns with industry trends.

Overall, Watsco appears well-positioned strategically, but near-term market conditions remain mixed. Management’s focus on operational efficiency and long-term growth opportunities is encouraging for patient, long-term investors.

Earnings Call Analysis 2024 Q1

Gross Margins

Watsco’s gross margins were impacted in Q4 2023 by some one-time factors like prior year pricing gains and inflation-related inventory gains that did not repeat. Management expects gross margins to improve sequentially in Q1 2024 as these headwinds subside, though they may still be below the long-term 27% target. The transition to new A2L refrigerants could provide an opportunity for margin expansion in the future.

Inventory Management

Watsco has been aggressively reducing inventory levels, which were down $208 million in Q4. They are aiming to drive higher inventory turns going forward through better data and visibility. This should generate more cash flow. The transition to A2L products may require some temporary restocking, but Watsco is planning for this.

Productivity Initiatives

Watsco is focused on driving long-term productivity gains across the business, targeting reductions in SG&A as a percentage of sales. This is an ongoing process, not a one-time restructuring.

Regulatory Tailwinds

The transition to new A2L refrigerants and other regulatory changes are seen as positive for Watsco’s business, driving demand for new equipment upgrades.

Acquisition Strategy

Watsco continues to pursue acquisitions of smaller, high-quality distributors to expand its scale and geographic reach. The company’s strong balance sheet is an advantage in this regard.

Overall, Watsco appears well-positioned for the long-term, with a focus on operational improvements, regulatory tailwinds, and strategic acquisitions. The near-term environment has some uncertainties, but management seems confident in the company’s ability to navigate them.

Earnings Call Analysis 2023 Q4

Long-term Growth and Profitability

Watsco is focused on long-term growth and profitability, not just short-term quarterly results. The management team emphasized their “continuous improvement culture” and technology investments to drive productivity and margin expansion over time.

Product Transition

The company is navigating a major product transition, with 60% of the HVAC systems they are selling now being new, higher-efficiency models. This transition has created some short-term supply chain and product availability challenges, but Watsco is working closely with its OEM partners to resolve these issues.

Regulatory and Industry Catalysts

Watsco sees several regulatory and industry catalysts, such as the refrigerant transition and new efficiency standards, as long-term growth opportunities that play to its strengths in scale, technology, and financial flexibility.

Short-term Guidance

The management team was cautious about providing specific short-term guidance, preferring to focus on the long-term trajectory of the business. They emphasized the inherent volatility in the HVAC distribution industry due to factors like weather.

Refrigerant Transition

Analysts probed for more details on the potential financial impact of the upcoming refrigerant transition, but the company acknowledged there is still significant uncertainty around the timing and magnitude of price increases for both new and existing equipment.

Acquisition Strategy and Partnerships

Watsco’s acquisition strategy and focus on partnering with entrepreneurial HVAC distributors appears to be a key part of its long-term growth plan, providing access to new markets and talent.

Overall, the call highlighted Watsco’s long-term orientation, its technology-driven productivity initiatives, and its ability to navigate industry transitions – all of which suggest a resilient business model for long-term investors.

Earnings Call Analysis 2023 Q3

Product Transition Challenges

Watsco is navigating a challenging product transition, with around 60% of the equipment they are selling being new or revamped products. This has led to some product availability issues, particularly with one of their primary OEM partners.

Maintaining Margins

Despite the product transition challenges, Watsco has maintained strong gross margins of 28.1% in the quarter, reflecting their disciplined pricing approach and continued progress on their pricing technology investments.

Long-Term Industry Catalysts

Watsco sees several long-term catalysts that will benefit the industry, including higher efficiency standards, new refrigerant standards, the shift towards electrification and heat pumps, and potential consumer incentives from the Inflation Reduction Act. They believe their scale, technology, and financial strength position them well to capture these market opportunities.

Technology Investments

Watsco is highly focused on technology investments, with a team of around 300 people dedicated to driving innovation and process improvements across the business. They see significant ongoing opportunities to apply technology and see it as a key competitive advantage.

Inventory Management

While the company has seen some inventory imbalances due to the product transition, they believe they can reduce inventory by another $200 million when things settle down, which would be beneficial for inventory turns and cash flow.

Long-Term Margin Aspirations

Watsco is maintaining a long-term aspiration of reaching 30% gross margins, though they did not provide a specific timeline. They see opportunities in their non-equipment sales, the shift towards higher-margin heat pumps, and continued benefits from their technology investments.

Overall, the key message is that Watsco is navigating near-term challenges well, while positioning itself for long-term growth through technology, product mix shifts, and regulatory tailwinds in the HVAC industry.

Earnings Call Analysis 2023 Q2

Competitive Advantage

Watsco has a strong competitive advantage through its broad product and brand offerings, leading market share in key markets, and significant technology investments that are driving customer engagement, reducing attrition, and supporting margins.

Industry Catalysts

There are several important regulatory and industry catalysts for growth in the coming years, including new efficiency standards, refrigerant changes, and increased electrification/heat pump adoption – Watsco is well-positioned to capitalize on these trends.

Market Share Gains

Watsco is focused on driving market share gains, even in a potentially softer demand environment, leveraging its scale, technology, and financial strength.

Margin Optimization

Gross margins remain strong, though there was some near-term pressure from the timing of OEM price increases. Watsco expects to see continued benefits from its pricing and margin optimization initiatives.

Inventory Management

Inventory levels are elevated due to supply chain challenges, but Watsco is working to improve inventory turns and cash flow as the year progresses.

M&A Strategy

Watsco remains active on the M&A front, seeing its strong culture and long-term focus as a competitive advantage over private equity buyers in acquiring family-owned distributors.

Overall, the commentary suggests Watsco is well-positioned for long-term growth, with a focus on leveraging its competitive advantages and industry tailwinds to drive market share and profitability, even in a potentially more challenging near-term environment.

Earnings Call Analysis 2023 Q1

Operational Efficiency Focus

Watsco is focused on improving operational efficiencies across its network to drive profitability, with the goal of having SG&A grow no faster than revenue, even if industry volumes are pressured.

Inventory Management

Watsco expects to reduce inventory levels by around $200 million as lead times normalize and the transition to new product models is completed. This should lead to improved cash flow.

Pricing and Mix

Watsco expects continued pricing power and favorable product mix, with heat pumps and ductless systems growing faster and carrying higher margins. Analysts estimate mid-to-high single digit price/mix tailwinds in 2023.

Growth Opportunities

Watsco is actively working with OEMs to develop growth initiatives, leveraging regulatory changes (new efficiency standards, refrigerant transitions) and industry trends (electrification, heat pump adoption) as catalysts. The company aims to gain market share through these initiatives.

Financial Strength

Watsco maintains a strong balance sheet with low debt, providing flexibility to invest in growth opportunities. The company generated record cash flow in 2022.

International and Commercial Segments

While the residential market may see some near-term volume pressure, Watsco’s international and commercial businesses remain strong, providing diversification.

Overall, Watsco appears well-positioned to navigate industry dynamics and capitalize on long-term growth opportunities through its operational focus, product breadth, and financial strength. The company’s long-term orientation and collaborative approach with OEMs are key differentiators.

Earnings Call Analysis 2022 Q4

Watsco is a Technology-Driven Company

Watsco is a technology-driven company that sells HVAC products. They have invested heavily in technology over the past 2 years to modernize their operations and improve the customer experience. This technology advantage is helping them gain market share.

The company is seeing strong demand trends, with sales of higher-efficiency heat pump products growing 27% in the first 9 months. Upcoming regulatory changes and government incentives are expected to further drive demand for more efficient HVAC systems.

Leading Market Share Position

Watsco has a leading market share position in the Sun Belt markets, where population migration and HVAC demand is highest. This geographic focus is a competitive advantage.

Improving Operational Efficiencies

The company is focused on improving operational efficiencies across its network as supply chain challenges ease. This includes optimizing inventory levels, reducing freight costs, and leveraging technology to drive productivity.

Stable Gross Margins

Gross margins remain strong, with the core “selling margin” up 80 basis points in Q3. However, there was some volatility in rebates and freight costs that offset this. Management expects gross margins to stabilize around 27% going forward.

Strong Balance Sheet and Growth Opportunities

Watsco has a strong balance sheet and is well-positioned to invest in growth opportunities, including expanding relationships with HVAC manufacturers and developing new customer-facing technologies.

Overall, the key takeaway is that Watsco is a well-run, technology-focused distributor that is poised to capitalize on long-term trends in the HVAC industry. The company’s competitive advantages and growth initiatives make it an attractive long-term investment.

Earnings Call Analysis 2022 Q3

Watsco is well-positioned to capitalize on upcoming regulatory changes in the HVAC industry:

The minimum federal SEER standards will increase in 2023, leading to higher-priced products that should benefit Watsco. The industry is transitioning to new refrigerants in 2025, which will require homeowners and businesses to upgrade their systems, providing growth opportunities for Watsco.

Watsco’s technology investments are paying off:

The company’s pricing optimization tools are enabling it to effectively capture price increases and pass them on to customers. Watsco’s technology is driving higher customer engagement, reduced attrition, and substantial market share gains.

Watsco’s diverse product portfolio and focus on the Sunbelt markets provide advantages:

The breadth and diversity of products across dozens of brands and hundreds of categories allow Watsco to offer a range of price points. The company’s concentrated position in the Sunbelt markets, where HVAC demand is highest, is a strategic advantage.

Watsco is proactively addressing SG&A challenges:

The company recognizes the need to improve operating efficiencies as supply chain and business disruptions normalize. Watsco is challenging its teams to identify and implement productivity improvements across various cost categories.

Watsco remains cautiously optimistic about 2023:

While the company expects higher interest rates and potential economic slowdown, it is confident in its ability to sustain growth and build market share. The regulatory changes and Watsco’s technology, scale, and financial strength position the company well for future opportunities.

Overall, the key insights suggest that Watsco is a well-positioned, technology-driven distributor that is proactively managing challenges and positioning itself for long-term growth, despite potential near-term macroeconomic headwinds.

Earnings Call Analysis 2022 Q2

Watsco’s Pricing Power and Operational Efficiency

Watsco is benefiting from strong demand and pricing power across its markets and product groups. The company is able to pass on price increases to customers due to the essential nature of HVAC products.

Upcoming regulatory changes, such as higher efficiency standards and refrigerant phase-outs, present opportunities for Watsco to sell more high-efficiency systems and benefit from the transition. The company is working closely with OEMs to manage this transition.

Watsco’s technology investments, including e-commerce, digital sales platforms, and pricing optimization tools, are enabling the company to improve operational efficiency, pricing, and customer engagement. This appears to be a key driver of the expanding gross margins.

The company does not seem overly concerned about potential demand destruction from inflation and rising interest rates, citing the non-discretionary nature of HVAC replacements and the importance of contractor relationships in guiding customers.

Margin Expansion and Profitability

Watsco is focused on continuously improving its gross and operating margins through a combination of pricing actions, product mix shifts, and operational efficiencies. The company believes it has significant runway to further enhance profitability.

The analysts’ questions suggest they are closely scrutinizing the sustainability of Watsco’s margin expansion, the impact of inventory management ahead of regulatory changes, and the company’s ability to navigate labor challenges. Watsco’s responses indicate confidence in its ability to maintain its strong performance.

Overall, the call highlights Watsco’s pricing power, operational excellence, and strategic positioning to benefit from industry trends, which appear to be driving the company’s impressive financial results. The long-term investor should focus on the company’s ability to sustain these advantages over time.

Earnings Call Analysis 2022 Q1

Positioning for Climate Change and Regulations

Watsco is well-positioned to benefit from the increasing focus on climate change and regulations around higher efficiency HVAC equipment and refrigerants. The company estimates its sales of more efficient systems have helped avoid 10.1 million metric tons of CO2 emissions over the past two years.

Technology Transformation

Watsco is making significant investments in technology to transform the contractor customer experience, with initiatives like e-commerce driving higher adoption and customer stickiness. However, there is still room for improvement in driving broader technology adoption across the contractor base.

Pricing Power and Margin Expansion

Pricing power remains strong, with Watsco able to pass through manufacturer price increases and realize margin expansion. The company expects this pricing environment to continue, driven by factors like the upcoming SEER efficiency standard changes and refrigerant regulations.

Inventory Management

Inventory levels, while up sequentially, are in line with the company’s outlook and the need to reestablish inventory given supply chain challenges. Watsco does not expect significant pre-buying ahead of the SEER changes.

Growth Opportunities

Watsco’s large scale, access to capital, and collaborative relationships with HVAC manufacturers position it well to capitalize on industry trends and growth opportunities. The company is focused on both organic growth and strategic acquisitions to build scale in the fragmented North American market.

Overall, the call highlights Watsco’s strong competitive position, pricing power, and long-term focus on sustainability and technology – factors that should benefit the company as a long-term investment.

Earnings Call Analysis 2021 Q4

Watsco’s Geographic Diversity and Stability

Watsco has strong geographic diversity and a large customer base, which provides stability during challenging operating environments. This diversification helps reduce volatility.

Technology Investments and Customer Benefits

The company is investing heavily in technology to improve pricing, margins, and help customers grow their businesses. These technology initiatives are showing benefits in terms of higher customer engagement and lower customer attrition.

Supply Chain Challenges and Inventory Management

While the supply chain challenges persist, Watsco is working closely with its OEM partners to try to balance inventory and fulfill the robust underlying demand. However, the company is not seeing a clear resolution to the supply chain issues yet.

Pricing Power and Product Mix Shift

Pricing power remains strong, with Watsco able to pass through price increases to customers. The company is seeing some shift in product mix towards more basic efficiency models due to supply constraints on higher efficiency units.

Long-Term Investments and Decentralized Approach

Watsco is taking a long-term view on investments and is committed to continuing to invest in technology and other initiatives despite near-term fluctuations in demand or margins. The company has a decentralized, data-driven approach to managing costs and profitability.

Potential Pre-Buy Ahead of SEER Efficiency Changes

The analysts are probing for any signs of a potential pre-buy ahead of the upcoming SEER efficiency changes, but Watsco does not see that as a significant factor currently given the supply constraints.

Overall, Watsco appears to be executing well in a challenging environment, leveraging its scale, technology, and customer relationships to drive strong financial performance. The long-term focus and investments in the business are key positives for a long-term investor.

Earnings Call Analysis 2021 Q3

Gross Margins

Gross margins have been exceptionally strong, expanding 220 basis points in the quarter. This is attributed to factors like selling more high-efficiency systems, effective pricing management, and working closely with OEMs on pricing. The company believes the high gross margin performance can continue, though likely at a more moderate pace going forward. They have invested in pricing expertise and technology to optimize pricing.

Parts and Supplies Business

Watsco is focused on growing its higher-margin parts and supplies business, which has been accelerating in growth and now makes up about a third of total sales. They are leveraging their sales force, incentives, e-commerce, and other initiatives to drive this.

Financing Opportunities

The company sees the financing of equipment purchases as an important opportunity, though they haven’t fully determined the best approach yet – whether to build it out themselves or partner with others.

M&A Strategy

On M&A, Watsco believes the strong industry environment helps the discussion with potential acquisition targets, but the emotional/cultural fit is more important than just the financial aspects.

Technology Investments

Watsco is heavily investing in technology and digital tools to drive growth, improve customer relationships, and promote higher-efficiency equipment sales, which they see as beneficial for climate change.

Market Share Gains

The company is confident in its ability to continue gaining market share, leveraging its scale, inventory management, and customer-centric approach compared to smaller competitors.

Back to Table of Contents

The information provided on this blog is for informational purposes only and should not be considered as financial advice. You should consult with a qualified financial professional before making any investment decisions. Past performance is not indicative of future results. Investing involves risk, including the potential loss of principal.