Company Reports

Residential heating, ventilation, and air-conditioning unit shipments remain under pressure in the wake of very robust demand in 2021-22. Nevertheless, Watsco’s first-quarter revenue increased approximately 1% year over year, although same-store revenue was 2% lower than the prior-year period. Still, Watsco’s first-quarter revenue was 2% shy of the FactSet consensus estimate. While first-quarter gross margin of 27.5% was above management’s near-term target of 27%, it was 140 basis points lower year over year. And with selling, general, and administrative expenses about 8% higher year over year, Watsco’s operating margin contracted 250 basis points to 8.1%, and EPS of $2.17 was 5% below the consensus estimate.

Watsco is the largest player in the fragmented heating, ventilation, air conditioning, and refrigeration distribution industry with a mid- to high-teens percentage market share. The company mostly operates in the United States (about 90% of sales) with an outsize presence in the Sunbelt states.

New single-family home sales increased 4% in 2023 to 666,000 units, as homebuilders capitalized on a dearth of existing for-sale inventory while also offering more sales incentives, cutting base home prices, and building smaller homes to improve affordability. By the fourth quarter of 2023, homebuilders began to pull back on sales incentives as the average 30-year fixed mortgage rate retreated from 7.62% in October 2023 to 6.64% in January 2024. However, mortgage rates have trended higher recently, and we now forecast the average 30-year fixed rate will be 6.50% in 2024, up from our previous forecast of 6.10%. Even so, that’s lower than the 2023 average of 6.81%, and we think homebuilders won’t hesitate to increase sales incentives if needed; they still enjoyed above-average gross profit margins last year with elevated incentives. As such, in 2024, we think new-home sales will increase 9% to 730,000 units and single-family housing starts will increase 4% to 985,000 units. However, we expect total housing starts will decline roughly 5% to 1,345,000 units due to a 23% decline in multifamily starts to 360,000 units, as there’s currently approximately 1,000,000 multifamily units under construction—the largest backlog in at least 50 years.

Shares of Watsco traded lower on Feb. 13 after the narrow-moat-rated heating, ventilation, and air conditioning distributor reported fourth-quarter results that fell short of FactSet consensus expectations. Fourth-quarter revenue of $1.6 billion increased 1% year over year (down 2%, excluding acquisitions) but was about 3% shy of the consensus estimate, while EPS of $2.06 decreased 12% compared with the prior-year adjusted figure and was roughly 15% below consensus. Even so, 2023 was a strong year for Watsco considering residential HVAC demand in the United States significantly softened after two years of above-average demand. Indeed, according to the Air-Conditioning, Heating & Refrigeration Institute, industry shipments of air conditioners, heat pumps, and furnaces declined about 18% year over year in 2023, returning to prepandemic levels.

Watsco is the largest player in the fragmented heating, ventilation, air conditioning, and refrigeration distribution industry with a mid- to high-teens percentage market share. The company mostly operates in the United States (about 90% of sales) with an outsize presence in the Sunbelt states.

New-home sales have rebounded since the spring of this year as sales incentives and price reductions have attracted buyers who have fewer options in the supply-constrained existing-home market. That said, homebuilder sentiment data tells us that smaller builders remain cautious. Even so, we forecast single-family starts to increase by 3% in 2024, to 0.92 million units. However, we project this increase in single-family starts will be more than offset by a 24% decline in multifamily starts, to 0.36 million units. Multifamily construction has been robust for the past three years, but a record construction backlog and higher construction and financing costs have tamed developers' appetite for new multifamily projects.

According to the Air-Conditioning, Heating, and Refrigeration Institute, year-to-date (through August) shipments of air conditioners, heat pumps, and furnaces were 16% lower than last year. Nevertheless, we think Watsco is on pace for flattish year-over-year revenue growth this year due to favorable price and product mix, and to a much lesser extent, revenue contribution from the September acquisition of Gateway Supply Company, with $180 million of annual sales.

Watsco is the largest player in the fragmented heating, ventilation, air-conditioning, and refrigeration distribution industry with a mid- to high-teens percentage market share. The company mostly operates in the United States (about 90% of sales) with an outsize presence in the Sunbelt states.

New-home sales have remained resilient despite worsening housing affordability in recent months amid rising mortgage rates, with little relief in home prices in most markets. Year-to-date new-home sales through July were about even with the year-ago period, compared with a 22% decline in existing-home sales. The key to homebuilders’ relative success this year has been their ability to improve affordability by offering sales incentives, lowering base prices, and building smaller homes. According to the National Association of Home Builders, the share of builders offering incentives was 55% in August, up from 52% in July but down from 62% last year. One fourth of homebuilders reported lowering base prices by 6% on average. Homebuilders have also boosted production of speculative homes to capitalize on the tight supply of existing for-sale homes. Spec building also helps builders better manage construction cycle times and costs.

Considering recent outsize demand for HVAC systems (causing a tough prior-year sales comparison) and our view that the U.S. residential HVAC replacement cycle has matured, we’ve been expecting a down year for HVAC shipments in 2023. Nevertheless, Watsco’s second-quarter revenue growth fell short of our expectations, falling 6% year over year. That said, product availability issues (related to the energy efficiency standard changeover) with a key original equipment manufacturer partner were likely to blame for much of the shortfall; management estimates that this supply issue reduced sales by $75 million-$80 million. We don’t believe this will be an ongoing issue.

Watsco is the largest player in the fragmented heating, ventilation, air-conditioning, and refrigeration distribution industry with a mid- to high-teens percentage market share. The company mostly operates in the United States (approximately 90% of sales) with an outsize presence in the Sunbelt states.

Through the first four months of 2023 (typically viewed as the “spring selling season” for homebuilders) new home sales significantly outperformed existing home sales. Indeed, April year-to-date new home sales declined roughly 10% year over year compared to over a 26% decline for existing home sales. New home sales improved sequentially during the first four months of the year, and April sales increased 11% year over year, albeit on an easy prior-year comparison (April 2022 new sales were down 24% year over year).

Heating, ventilation, and air-conditioning demand appears to be normalizing following a period of booming sales during the pandemic. According to data from the Air-Conditioning, Heating, & Refrigeration Institute, year-to-date (through February) United States shipments of air conditioners and heat pumps were down over 15% year over year, and shipments of furnaces were down 19%.

Watsco is the largest player in the fragmented heating, ventilation, air-conditioning, and refrigeration distribution industry with a mid- to high-teens percentage market share. The company mostly operates in the United States (approximately 90% of sales) with an outsize presence in the Sunbelt states.

U.S. home sales slowed significantly in 2022 as rising mortgage rates and elevated home prices made homeownership less affordable for more Americans. By mid-2022, the average 30-year fixed mortgage rate had increased roughly 300 basis points year over year to over 6%. According to estimates from the National Association of Home Builders, this rate increase priced out more than 16 million households. We also think higher rates and general economic uncertainty caused some qualified prospective buyers to move to the sidelines. All told, 2022 new- and existing-home sales declined 17% and 18% year over year, respectively.

Shares of Watsco surged intraday on Feb. 16 after the narrow-moat-rated distributor of heating, ventilation, air-conditioning (or, HVAC), and refrigeration products reported another record quarterly financial performance. Fourth-quarter revenue increased approximately 5% year over year (but sales of $1.58 billion fell about 2% shy of the FactSet consensus estimate), adjusted operating margin remained well above prepandemic levels (8.9% compared with fourth-quarter 2019’s 4.9%), and adjusted EPS increased 16% year over year to $2.35 (beating consensus by approximately 11%).

Watsco is the largest player in the fragmented heating, ventilation, air-conditioning, and refrigeration distribution industry with low-double-digit percentage market share. The company mostly operates in the United States (approximately 90% of sales) with an outsize presence in the Sunbelt states.

After analyzing recent United States housing market data and industry commentary, we've made downward revisions to our near-term outlook for new residential construction, home prices, and repair and remodel spending.

Watsco reported strong third-quarter results that nevertheless missed consensus expectations for the narrow-moat-rated distributor of heating, ventilation, air-conditioning, and refrigeration products. Indeed, while revenue grew 14% year over year (to over $2 billion) and EPS of $4.03 increased 11%, reported revenue and EPS fell about 1% and 9% below FactSet consensus estimates, respectively. Watsco’s third-quarter results largely met our expectations, although operating margin came in a bit lighter than we were modeling (11.6% compared with our 11.9% projection). We believe Watsco’s lower-than-consensus third-quarter EPS was likely due to the firm’s gross margin, which contracted 80 basis points sequentially (although flat year over year) to 27.1%.

Watsco is the largest player in the fragmented heating, ventilation, air-conditioning, and refrigeration distribution industry with low-double-digit percentage market share. The company predominantly operates in the United States (approximately 90% of revenue) with an outsize presence in the Sunbelt states.