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Watsco Keeps Cooling Off

By Dan Caplinger – Apr 23, 2019 at 4:15AM

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A slow start to spring hurt the HVAC specialist's results.

Watsco (WSO 0.92%) is a leader in providing the heating, ventilation, and air conditioning systems that commercial and residential customers need in order to be comfortable. Amid strong economic conditions in the U.S., Watsco has prospered, but recently, signs of slowing growth have emerged that show just how difficult it is to sustain positive momentum in the HVAC business even when times are good.

Coming into Tuesday's first-quarter financial report, Watsco investors were looking to see modest sales gains but were prepared for a slight decrease in profit. The company saw its revenue grow even more slowly than many had expected, and that left unresolved some of the concerns that investors have about whether Watsco can reignite its growth once the high season for air conditioning hits.

Two people shaking hands next to an air conditioning unit with a third person watching, next to a brick house with nearby shrubs.

Image source: Watsco.

A spring slowdown for Watsco

Watsco's first-quarter report reflected the slow-growth environment that the company has faced for several months now. Revenue was up just 0.5% to $931.3 million, falling short of the 2% growth rate that those following the stock had projected. Net income rose 2% to $35 million, but on a diluted basis, earnings of $0.88 per share were down 1% from year-ago levels and only matched the consensus forecast among investors.

For the first time in a while, Watsco saw declines in some key business segments. Although the primary HVAC equipment division managed to grow revenue by 2%, sales of other HVAC products were down 2% from year-ago levels. The commercial refrigeration products division saw even steeper top-line declines, posting a 4% drop from where they were 12 months ago. Those tepid sales numbers led to flat performance on a same-store basis, with the modest gain coming solely from a dozen new locations.

Yet Watsco did see some progress in key profit-driving initiatives. Gross margin inched higher by 0.2 percentage points to 25.1%, and a modest rise in overhead expenses helped improve operating margin fractionally as well. However, amounts attributable to nonvested restricted common stock for employees weighed on the bottom line.

CEO Albert Nahmad tried to explain what held the company back. "The first quarter is historically the most seasonal quarter of the year," Nahmad said, "yet we achieved record profitability despite cooler and wetter weather in certain markets, strong year-over-year sales comparisons, and one less selling-day in 2019 versus 2018." The CEO also pointed to the ongoing use of technological innovation to help sales professionals be more productive.

What's next for Watsco?

Watsco is optimistic about the future, with Nahmad saying that he believes 2019 will set more records for the company. On the technology front, the availability of its e-commerce site and mobile app has given Watsco's customers newfound abilities to have their needs met. Internally, a new business intelligence platform, proprietary order-fulfillment software, and inventory optimization programs have all made it easier for workers to do their jobs. The recent acquisition of Internet of Things specialist Alert Labs should help accelerate the growth driven by these high-tech solutions.

At the same time, expansion remains important to Watsco's strategic plans. The company recently completed its acquisition of New Jersey-based DASCO Supply, which will add to Watsco's exposure to the greater New York City metropolitan area with locations in New Jersey, New York, and Connecticut.

Overall, a balanced approach to growth seems to be Watsco's answer to its current sluggishness. In the CEO's words, "As entrepreneurs with a long-term point of view, we are proud to deliver another record quarter with increasing dividends while continuing to strategically invest in transforming our customer experience."

Watsco investors didn't seem entirely satisfied with that perspective, and the stock fell about 1% in premarket trading following the announcement. With signs of a continued slowdown in its HVAC business, Watsco needs to find new avenues to drum up more business and reassert the strength that has brought it so far over the years.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Watsco. The Motley Fool has a disclosure policy.

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