Watsco (WSO 1.48%), the largest distributor of HVAC/R (heating, ventilation, air conditioning, and refrigeration) equipment in North America, delivered its third-quarter earnings results on Oct. 23. While it announced record quarterly revenue of $2.16 billion, reflecting a 2% growth year over year, it did not meet analysts' consensus expectation of approximately $2.24 billion. Moreover, its earnings per share (EPS) declined to $4.22 from the prior year's $4.35, coming in well below the anticipated $4.73. Despite these challenges, the quarter featured significant improvements in operating efficiency and cash flow.
| Metric | Q3 2024 | Q3 2024 Analyst Estimate | Q3 2023 | % Change YOY |
|---|---|---|---|---|
| Revenue | $2.16 billion | $2.24 billion | $2.13 billion | 2% |
| Earnings per share | $4.22 | $4.73 | $4.35 | (3%) |
| Operating income | $250 million | — | $257 million | (2%) |
| Operating cash flow (9 months) | $394 million | — | $263 million | 50% |
Source: Analyst estimates for the quarter provided by FactSet.
Understanding Watsco's Business and Strategy
Watsco is a major wholesaler of heating, ventilation, air conditioning, and refrigeration equipment across North America. With its network of over 690 locations, the company serves more than 125,000 active contractors, and enjoys an enviable market presence across the U.S., Canada, Mexico, and the Caribbean. Watsco's strong supplier relationships with major providers like Carrier Global fortify its market standing.
The company's recent strategic priorities have centered on technological adaptations and growth via acquisitions. By enhancing its digital sales frameworks and integrating acquired businesses, Watsco aims to fortify its leadership in the HVAC/R distribution segment.
Financial and Operational Highlights
Watsco's latest report contrasts record-breaking sales with unmet earnings expectations. Its revenue growth was primarily driven by an 8% increase in HVAC equipment sales, which makes up 71% of its total sales. Sales in other HVAC and commercial refrigeration products decreased by 2% and 4%, respectively.
The company's operating income declined by 2% to $250 million. Gross margins tightened from 26.7% to 26.2% as Watsco made strategic investments with an original equipment manufacturer. According to management, these investments, aimed at reclaiming market share and attracting new clients, have effectively compressed its gross margins by approximately 30 basis points year to date.
Technology updates led to notable digital sales growth; e-commerce sales now represent 35% of total sales. Platforms like Watsco's Product Information Management system and HVAC Pro+ Mobile Apps have helped boost this digital momentum. Meanwhile, its strategic acquisitions since 2019 have added around $1 billion in annual sales, exemplifying the company's acquisition-centric growth strategy.
Over the first nine months of 2024, Watsco achieved a 50% year-over-year increase in operating cash flow to $394 million. Yet supplier concentration risks and margin pressures loom as obstacles, particularly as the company is highly dependent on a limited group of manufacturers.
Planning Ahead: Watsco's Strategic Direction
Watsco's management has indicated that it will continue to focus on strategic investments as the HVAC/R market adapts to new regulations and environmental standards. Next year, regulations will come into effect that will begin a shift toward the use of climate-friendly A2L refrigerants. That transition, which management expects will impact 60% of its sales, is expected to drive future growth.
Investors should closely observe Watsco's advances in e-commerce and how it adapts to the changing regulatory environment, as well as any adjustments to its guidance that it may make amidst these ongoing transitions.
