Key Points
Watsco stock missed on both sales and earnings this morning.
The HVAC distributor is growing slowly, but buying companies in an attempt to spur growth.
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Watsco (NYSE: WSO) stock tumbled 15.3% through 10:45 a.m. ET Wednesday after missing badly on earnings this morning.
Analysts had forecast that the HVAC equipment distributor would earn $4.41 per share on more than $2.1 billion in Q2 sales. In fact, Watsco earned $4 per share, and its sales fell just short of expectations.
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Watsco Q2 earnings
Watsco calls itself "the largest distributor in the highly fragmented North American HVAC market," but business isn't exactly booming in this market. The company grew its revenues only 2% year over year in Q2, and gross profit declined while operating costs rose.
"Thanks" to this dynamic -- slow growth, rising costs, and falling profits -- Watsco's earnings declined 12% year over year.
What's next for Watsco
So how does Watsco improve on this? By buying growth. The company purchased Jackson Supply, "among largest Sunbelt HVAC distributors" last month, and "continues to actively seek new businesses that will join the Watsco family."
In a fragmented market like Watsco says HVAC is, that's a viable way forward, and Watsco certainly has cash available to fund it. Debt levels aren't much above cash on hand, and over the last 12 months, free cash flow at the company approached $700 million -- far more than reported net income.
That said, trading at a valuation of roughly 20 times FCF but growing only modestly, Watsco stock looks overpriced to me. If the roll-up strategy changes this picture, I reserve the right to change my opinion -- but for now I do not consider Watsco stock a "buy."
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Watsco. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
