Watsco Inc. (WSO) has reported fiscal 2011 second quarter results, registering an EPS of $1.09, higher by a penny from the year-earlier quarter, but below the Zacks Consensus Estimate of $1.30.
Total revenue increased 2% year over year to $884 million in the reported quarter, this included $46 million added by new locations. During the quarter Same-Store-Sales decreased 2%, including a 5% decline in air conditioning and heating (HVAC) equipment, 1% decrease in other HVAC products, offsetting this was an 8% increase in commercial refrigeration products.
Costs and Margins
Costs of sales in the quarter increased to $670.4 million from $663.7 million in the year-earlier quarter. Gross profit was up 6% year over year to $213.2 million, thereby expanding the gross margin by 80 basis points year over year to 24.1% in the quarter. On a same-store basis gross profit was up 1% year over year, while gross margins increased 90 basis points year over year to 24.1%.
SG&A expenses during the quarter increased slightly to $137.7 million from $130.1 million in the year-ago quarter. Income from operations soared to $75.5 million from $70.9 million in the prior-year quarter. Consequently, operating margin also increased 30 basis points year over year to 8.5%.
Financial Position
As of June 30, 2011, cash and cash equivalents declined sharply to $18.6 million from $126.5 million as of December 31, 2010. Debt-to-total-capitalization ratio for the same period remained at 6%.
During the reported quarter, Watsco generated cash flow of $3.0 million from operating activities. During the month of April, Watsco also raised its dividend rate 10.0% to 57 cents per share. Watsco has been paying incremental dividends since 2001.
Watsco and Carrier Joint Venture
Watsco recently announced the addition of Carrier Corporation’s HVAC distribution operations in Mexico to their existing joint venture. The transaction is expected to close on July 29, 2011.
Carrier’s Mexican operations began in 1947 and reported revenue of $80.0 million during the last twelve months ending June 2011. The company has its presence across six locations and currently has 90 employees serving its customer base.
Under the terms of agreement, Watsco will market Carrier’s complete product line from duct free split systems through the applied commercial systems. The Mexican market is estimated to have a potential of approximately $2.0 billion for HVAC equipment and commercial refrigeration products and supplies.
Opportunity for Watsco
With a population of 112 million and 11th largest economy in the world, Mexico possesses enormous growth potential for the company. Besides, Carrier has a strong brand equity in Mexico and a leadership team in place. Watsco has made commitment to foray into Mexican markets by adding non-equipment products in order to increase market share.
Besides, Mexico, United States is another potential market for Watsco, which currently has 74 million central air conditioning and heating systems installed, which are older than 10 years. These systems are generally below the government mandated energy efficiency and environmental standards. Thus, Watsco has a great opportunity to replace these older systems with its lower energy consumption and environment-friendly solutions.
Our Take
Watsco continues to increase its market share through strategic acquisitions and expansion of its product offering. The company’s joint venture with Carrier not only added new products to its sales mix, but also marked its entry into international markets with the addition of the Latin American and Caribbean sales operations as well as Northeastern U.S. Moreover, the company continues to benefit from the transition to higher-efficiency air-conditioning equipment.
However, decline in housing starts, reduction of the tax credit for homeowners for purchasing a high efficiency HVAC unit and higher costs of replacing with the R410A refrigerant, remain concerns. The shares of Watsco currently retain a Zacks #4 Rank (short-term Sell recommendation).
Watsco is the largest distributor of air conditioning, heating and refrigeration equipment as well as related parts and supplies in the United States. The company operates 508 locations serving over 50,000 customers in 36 states, Puerto Rico, Latin America and the Caribbean. Watsco competes with the likes of Johnson Controls Inc. (JCI), Gensco Inc and Gustave A. Larson Company.
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