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Heating and cooling systems are necessities for both commercial and residential properties, and Watsco (WSO 1.74%) makes it its business to ensure that customers have the HVAC systems they need in order to stay comfortable. In past quarters, demand for the equipment that Watsco distributes has been strong enough to support solid growth for the company. Coming into Friday's second-quarter expected the good times to continue for Watsco, and so the fact that the company failed to live up to those expectations came as a shock. Let's take a closer look at the latest from Watsco to see why the HVAC specialist had such a big departure from its usual success.
Watsco gets a late start
Watsco's second-quarter report showed uncharacteristically poor performance from the company. Sales fell 1% to $1.21 billion, defying expectations for a 5% rise in revenue. Net income attributable to Watsco similarly dropped 1% to $64.6 million, and that produced earnings of $1.82 per share. That was actually down slightly from year-ago levels and was far below the $2.04-per-share consensus estimate among those following the stock.
Looking more closely at Watsco's figures, the company fell short of many of its past achievements during the quarter. Same-store sales were flat from year-ago levels, showing dramatic deceleration from past growth rates. A 2% rise in overhead expenses didn't seem all that problematic, but given falling revenue, it was enough to send the company's operating margin down by half a percentage point to 9.7%.
Watsco's three primary divisions were generally weak, with one small exception. The key HVAC equipment unit, which makes up two-thirds of revenue, saw sales drop 1%. The other HVAC products category suffered a 3% decline, and only the commercial refrigeration segment was able to post an increase, with revenue climbing 8%. Given that commercial refrigeration makes up only about 5% of Watsco's total business, the unit's success wasn't adequate to turn the tide.
CEO Albert Nahmad explained the reason for Watsco's unusually weak performance. "Our summer selling season started later than normal this year," Nahmad said, "and record sales and profits in June were insufficient to offset softer business conditions during the early part of the quarter." The CEO tried to reassure investors that the weak period was an aberration and that good times would soon follow.
Is Watsco bouncing back already?
Indeed, Watsco has already seen reason for optimism. As Nahmad explained, July sales trends have jumped back upward to produce double-digit percentage growth, and Watsco believes that profits will come in due course. In the long run, Watsco believes that its industry-leading technology, consumer acceptance of high-efficiency replacement equipment for HVAC systems, and internal efforts to boost efficiency and gain market share will pay off for shareholders.
Watsco was also able to respond to anticipated better conditions by boosting its dividend. The company raised its payout by 24%, and it will now pay $1.05 per share on a quarterly basis starting in October. Watsco explained that as the business becomes more profitable, it intends to keep sharing free cash flow through dividend payments while still having enough liquidity to make strategic acquisitions or other corporate moves designed to bolster growth.
Watsco investors took a bit of time to come to grips with the news. The stock initially dropped about 2% following the announcement, but by midday, Watsco shares were moving back upward and within striking distance of new all-time record highs. As long as the company's assertion that the recent weakness won't repeat itself in the near future, then Watsco investors seem content to ride the long wave of expansion to profits on their stock positions going forward.
