Watsco Rides on Investment in Technology, Replacement Demand

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On Feb 12, 2018, we issued an updated research report on Watsco Inc.WSO . The company is expected to benefit from investment in new technologies and products. Further, sustained replacement demand will allow it to sustain growth momentum.

Watsco reported adjusted earnings per share of 90 cents in fourth-quarter 2017, up 11% year over year. However, earnings missed the Zacks Consensus Estimate of $1.00. Total revenues in the quarter increased 5.6% year over year to $964 million. The figure missed the Zacks Consensus Estimate of $965 million.

Watsco delivered a record fourth quarter with a resumption of strong sales growth rates for residential and commercial HVAC (Heating, ventilation and air conditioning) systems that benefited from increasing unit demand and an improved mix of higher-efficiency systems. Results also reflect the company's investments in technology and 150 new customer-facing employees during the course of the year to drive sales growth and market share.

Investment in Technology to Drive Growth

Watsco is making continued investment in technologies to revolutionize the customer-experience. This will not only make it easier for the company to do business but also aid customers in growing their businesses more profitably. As the digital era progresses, speed, productivity and efficiency will be more critical. Consequently, the company is investing to improve customer-experience. Watsco stated that e-commerce sales generated 25% of its total sales.

During 2017, the company launched a variety of technologies and process enhancements to transform how HVAC contractor customers are served in the marketplace. Over the past five years, Watsco's has grown its technology team from approximately 60 employees to 180 employees and the present annual run-rate for technology-related spending is approximately $23 million.

Innovations to enhance the customer-experience include mobile apps, websites and e-commerce platforms that employ the industry's leading, data-rich repository of product information. Further, business intelligence and data analytics expertise will aid insightful assistance and decision-making by managers. Proprietary order fulfillment software will help improve speed, accuracy and convenience of the pick, pack and ship process. Predictive analytics-driven demand planning and inventory optimization software will help improve order fill-rates, increase inventory turns, reduce real estate requirements and improve long-term productivity.

Sound Balance Sheet to Aid Growth

Watsco generated record operating cash flow of $302 million in 2017 on net income of $257 million, reflecting a 9% increase year over year. During 2017, the company raised $248 million from the sale of shares of its common stock under its previously announced "at-the-market" (ATM) stock offering program. This aided the company in reducing debt and also poised it to capitalize on long-term growth opportunities. As of Dec 31, 2017, debt-to-total capitalization was 1%.

Watsco also announced that its Board of Directors approved a 16% increase in annual dividend to $5.80 per share for each outstanding share of Common and Class B common stock. Since 2000, Watsco's cash flow was approximately $2.2 billion compared with net income of approximately $2.0 billion, surpassing the company's stated goal of generating cash flow in excess of net income. Consequently, the company continues to look for investments to grow network as well as invest in acquisitions or mergers.

In June 2017, Watsco's Carrier Enterprise business unit acquired 35% ownership of Russell Sigler, Inc. The move is in sync with Watsco's strategic efforts to collaborate with well-established businesses and strengthen presence in significant Western U.S. markets. Additionally, Watsco has exclusive rights to purchase ownership interests from the current shareholders which may elect to sell in the future.

Replacement Demand Bodes Well

Watsco has immense growth potential in the replacement market, stemming from an aging stock of air conditioners and heating systems in the United States. The company is likely to benefit from the expansion of its product offerings, as well as logistical and productivity improvements. Over the long run, Watsco aims to slash infrastructure costs, which will provide the company with the opportunity to improve operating margins.

However, sales of residential central air conditioners, heating equipment, and parts and supplies have historically been seasonal. Furthermore, profitability remains subject to severity or mildness of weather patterns during the summer or winter selling seasons.

Watsco's stock has underperformed the industry in a year's time. The stock has gained around 9.5% compared with the industry's growth of 10.7%.

Watsco currently carries a Zacks Rank #2 (Buy).

Some other top-ranked stocks in the sector include Boise Cascade Company BCC , Potlatch Corporation PCH and MasTec, Inc. MTZ . While Boise Cascade Company and Potlatch Corporation sport a Zacks Rank #1 (Strong Buy), MasTec carries a Zacks Rank #2. You can see the complete list of today's Zacks #1 Rank stocks here .

Boise Cascade Company has a long-term earnings growth rate of 18.5%. Its shares have appreciated 58% in the past year.

Potlatch Corporation has a long-term earnings growth rate of 5%. The company's shares have gone up 15% during the same time frame.

MasTec has a long-term earnings growth rate of 14%. The stock has gained 29% in the past year.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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