Please ensure Javascript is enabled for purposes of website accessibility

Watsco Faces Slow Start to 2017 but Boosts Its Dividend

By Dan Caplinger - Apr 25, 2017 at 9:34AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The HVAC specialist still posted record sales and income and believes conditions are improving.

Seasonality affects many businesses, and for HVAC specialist Watsco (WSO -0.95%), the first quarter of the year is always an unpredictable period. With air conditioning system replacement typically coming during the spring and summer months, Watsco is vulnerable to seasonal lulls during the winter that can temporarily reduce demand.

Coming into Tuesday's first-quarter financial report, Watsco investors had hoped to see modest sales increases produce greater than 10% growth in earnings. Instead, a slow start was disappointing for the company, but Watsco believes sales trends have already improved after the end of the quarter and could point to better times ahead. Let's look more closely at Watsco's results and what they say about the current environment in the industry.

Air conditioner units.

Image source: Getty Images.

Watsco deals with a seasonal slump

Watsco's first-quarter report showed continuing difficult conditions for the company. Sales were up 2% to $872 million, which was a record for the first quarter, but still fell short of the consensus forecast among investors for $878 million in revenue. Net income rose 2.5% to $26.2 million, but after accounting for restricted stock and a rise in outstanding shares, earnings of $0.71 per share were flat from year-ago levels and far less than the $0.80 per share that those following the stock had expected.

Watsco continued to work hard to control costs but was only partially successful in doing so. Gross profit margin rose 10 basis points to 25.1%, but operating margin took a hit, falling from 6% a year ago to 5.6% during the most recent quarter. A rise of 5% in overhead expenses spurred the margin decline, and Watsco said that the boost came from expansion in the labor force among sales and service-related staff, along with higher spending on technology to make the company's workforce more productive.

On a segment-by-segment basis, there weren't any big standouts under Watsco's corporate umbrella. Sales of HVAC equipment were up 3%, perking up slightly from last quarter but still remaining subdued. Other HVAC product sales rose just 1%, and the commercial refrigeration unit managed a 5% rise, bouncing back from slowdowns late in 2016.

Watsco CEO Albert Nahmad again pointed to calendar issues in explaining the slowdown. "Sales trends during the quarter proved highly seasonal," Nahmad said, "especially in the face of last year's double-digit U.S. equipment growth rate comparison." The CEO also pointed to headcount additions of nearly 150 as contributing to higher costs but promising to boost growth in the future.

What's next for Watsco?

Watsco believes that the early spring has already shown signs of picking up. In Nahmad's words, "Sales momentum improved as the quarter closed, and current trends in April have accelerated to double-digit growth." Moreover, Watsco thinks that the mix of sales should also be more favorable going forward, as clients decide to upgrade to higher-efficiency systems that tend to carry stronger margins for the HVAC company.

Watsco's confidence in its long-term future also came out in its decision to raise its quarterly dividend. Beginning in July, Watsco will start paying shareholders $1.25 per share, which is up 19% from the current $1.05 quarterly rate of per-share dividends. Even with the boost, however, Watsco remains comfortable that it has enough cash flow remaining to consider strategic investments and put money back into growing its internal business.

Traders in Watsco won't be happy with the company's shortfall, worrying about any immediate hit the stock might take. But long-term investors understand Watsco's seasonality, and as long as the HVAC specialist can win back sales in subsequent quarters, they'll be content to enjoy the solid growth that Watsco offers.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Watsco. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Watsco, Inc. Stock Quote
Watsco, Inc.
$302.41 (-0.95%) $-2.89

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/16/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.