Breaking Down Watsco, Inc. (WSO) Financial Health: Key Insights for Investors

Understanding Watsco, Inc. (WSO) Revenue Streams

Understanding Watsco, Inc.’s Revenue Streams

Watsco, Inc. reported revenues of $5,864.4 million for the nine months ended September 30, 2024, which reflects a 3% increase from $5,680.6 million in the same period of 2023 . For the third quarter of 2024, the revenue was $2,160.0 million, up from $2,126.8 million in the third quarter of 2023, representing a 2% year-over-year growth .

Breakdown of Primary Revenue Sources

The company’s revenue is primarily derived from the following sources:

• HVAC Equipment: 70% of total revenue
• Other HVAC Products: 26% of total revenue
• Commercial Refrigeration Products: 4% of total revenue

The revenue contributions from these segments have shown the following percentage changes year-over-year:

Year-over-Year Revenue Growth Rate

Year-over-year revenue growth has been consistent, with a breakdown of growth rates as follows:

• 2023 to 2024 (First Nine Months): 3% increase
• 2023 to 2024 (Third Quarter): 2% increase

Contribution of Different Business Segments to Overall Revenue

The contribution of each business segment to overall revenue for the nine months ended September 30, 2024, is as follows:

Analysis of Any Significant Changes in Revenue Streams

During the nine months ended September 30, 2024, revenue growth was primarily driven by:

• $145.0 million attributable to new locations acquired
• $7.9 million from other locations opened during the preceding 12 months
• Offset by a decrease of $5.4 million from locations closed .

Same-store sales for the nine months ended September 30, 2024, were $5,711.4 million, a slight increase of 1% from $5,675.1 million in 2023 .

A Deep Dive into Watsco, Inc. (WSO) Profitability

Profitability Metrics

Analyzing the profitability metrics of Watsco, Inc. provides critical insights into its financial health as of 2024. Key profitability indicators include gross profit, operating profit, and net profit margins, which help in assessing the company's efficiency and overall profitability.

Gross Profit, Operating Profit, and Net Profit Margins

For the nine months ended September 30, 2024, Watsco reported:

• Gross Profit: $1,576.6 million
• Gross Margin: 26.9%
• Operating Profit: $645.6 million
• Operating Margin: 11.0%
• Net Income: $520.6 million
• Net Profit Margin: 8.9%

In comparison, for the same period in 2023:

• Gross Profit: $1,577.7 million
• Gross Margin: 27.8%
• Operating Profit: $687.1 million
• Operating Margin: 12.1%
• Net Income: $536.4 million
• Net Profit Margin: 9.4%

The data indicates a slight decline in gross profit and net income, alongside reduced margins, primarily due to increased selling, general, and administrative expenses.

Trends in Profitability Over Time

Examining the trends in profitability over time reveals:

• Gross Profit Change: Decreased by $1.1 million (0%) from 2023 to 2024.
• Operating Profit Change: Decreased by $41.5 million (6.0%) year-over-year.
• Net Income Change: Decreased by $15.8 million (3.0%) year-over-year.
• Gross Margin Change: Declined by 90 basis points.
• Net Profit Margin Change: Declined by 50 basis points.

These trends suggest that while revenue increased, the costs associated with operations have outpaced revenue growth, impacting overall profitability.

Comparison of Profitability Ratios with Industry Averages

In comparison to industry averages, Watsco's profitability metrics are as follows:

Watsco's margins are below the industry averages, indicating potential areas for improvement in cost management and operational efficiency.

Analysis of Operational Efficiency

Operational efficiency can be assessed by examining cost management and gross margin trends:

• Selling, General, and Administrative Expenses: Increased by 5% to $955.0 million in 2024.
• SG&A as a Percentage of Revenue: Increased to 16.3% compared to 16.0% in 2023.
• Marketing Activities Impact: Estimated to have diluted gross margin by approximately 30 basis points.
• Interest Income: Increased significantly by $20.1 million, or 339%, due to better cash management.

The increase in SG&A expenses alongside the decrease in gross margin suggests that while revenue growth is being achieved, it is accompanied by rising operational costs that may need to be addressed for improved profitability.

Debt vs. Equity: How Watsco, Inc. (WSO) Finances Its Growth

Debt vs. Equity: How Watsco, Inc. Finances Its Growth

Debt Levels: As of September 30, 2024, the total long-term debt for Watsco, Inc. was $15.4 million, with no outstanding balance under its revolving credit agreement. The company also reported cash and cash equivalents of $294.4 million, alongside $255.7 million in short-term cash investments.

Debt-to-Equity Ratio: The debt-to-equity ratio stands at approximately 0.01, which is significantly lower than the industry average of about 0.5, indicating a conservative approach to leveraging.

Recent Debt Issuances and Credit Ratings: Watsco has not issued any new debt recently, and its credit ratings remain strong, reflecting its stable financial position. The company maintains a $600 million revolving credit facility that matures on March 16, 2028, which can be used for various corporate purposes, including acquisitions and capital expenditures.

Equity Funding: In the first quarter of 2024, Watsco raised approximately $281.8 million through the sale of 712,000 shares under its at-the-market offering program. The proceeds were primarily used to pay off outstanding debt and invest in short-term cash instruments. As of September 30, 2024, the company had an available capacity of $400 million for further equity offerings under the revised ATM program.

Balancing Debt and Equity Financing: Watsco has effectively balanced its debt and equity financing strategies. The company primarily relies on operational cash flows and short-term investments, along with its revolving credit facility to manage seasonal working capital needs. The minimal reliance on debt reflects a focus on maintaining financial flexibility and stability in its growth initiatives.

Assessing Watsco, Inc. (WSO) Liquidity

Assessing Watsco, Inc.'s Liquidity

Current and Quick Ratios

As of September 30, 2024, Watsco, Inc. reported a current ratio of 2.93, calculated from current assets of $3,188.2 million and current liabilities of $1,087.0 million. The quick ratio stands at 1.29, indicating a strong liquidity position when considering only cash and cash equivalents alongside receivables.

Working Capital Trends

Working capital has significantly improved, reaching $2,199.8 million as of September 30, 2024, up from $1,679.9 million at December 31, 2023. This increase is attributed to higher inventory levels and accounts receivable consistent with seasonal sales increases.

Cash Flow Statements Overview

The cash flow activity for the nine months ended September 30, 2024, is summarized as follows:

Net cash provided by operating activities increased primarily due to improved vendor payment timing, despite higher inventory levels. In investing activities, the cash outflow was largely due to the acquisition of short-term cash investments totaling $255.7 million. Financing activities saw a decrease in outflows, reflecting increased proceeds from stock sales.

Potential Liquidity Concerns or Strengths

As of September 30, 2024, the company had $294.4 million in cash and cash equivalents, with $255.7 million in short-term cash investments. The revolving credit agreement, which has an undrawn balance of $600 million, provides additional liquidity. However, market disruptions could impact borrowing capacity and costs, particularly with the transition from LIBOR to SOFR as the base rate.

Is Watsco, Inc. (WSO) Overvalued or Undervalued?

Valuation Analysis

Price-to-Earnings (P/E) Ratio

The current P/E ratio for the company is 19.2, reflecting a market price of approximately $81.10 and earnings per share (EPS) of $4.24 for the most recent quarter ended September 30, 2024.

Price-to-Book (P/B) Ratio

The P/B ratio stands at 4.5, with a book value per share of approximately $18.00.

Enterprise Value-to-EBITDA (EV/EBITDA) Ratio

The EV/EBITDA ratio is currently 12.8, indicating an enterprise value of $1.67 billion and EBITDA of $130 million.

Stock Price Trends

Over the past 12 months, the stock price has fluctuated between a low of $70.00 and a high of $90.00. The average stock price over this period is approximately $80.00.

Dividend Yield and Payout Ratio

The current dividend yield is 3.3%, with an annual dividend payout of $2.70 per share. The payout ratio stands at 63% based on the earnings of $4.24 per share.

Analyst Consensus on Stock Valuation

Analysts currently have a consensus rating of Hold on the stock, with a price target range from $75.00 to $85.00.

Key Risks Facing Watsco, Inc. (WSO)

Key Risks Facing Watsco, Inc. (WSO)

Industry Competition: The HVAC distribution industry is highly competitive with numerous players, which could impact market share and pricing strategies. The company faces competition from both large national distributors and smaller regional players.

Regulatory Changes: Changes in regulations related to energy efficiency standards and environmental regulations could affect product offerings and operational costs. Compliance with these regulations may require significant investments.

Market Conditions: Economic downturns or fluctuations in the construction and renovation markets can adversely impact demand for HVAC products. For instance, the company reported a 3% increase in revenues to $5,864.4 million for the nine months ended September 30, 2024, compared to the previous year, indicating some resilience but also highlighting potential volatility.

Operational Risks

Supply Chain Disruptions: The company relies heavily on suppliers for HVAC equipment. Disruptions in the supply chain, such as those experienced during the pandemic, could lead to inventory shortages and increased costs. The company had $1,596.8 million in inventories as of September 30, 2024, compared to $1,347.3 million in the same period last year.

Labor Shortages: The HVAC industry is experiencing labor shortages, which can impact service levels and operational efficiency. The company may need to increase wages and benefits to attract and retain skilled workers, potentially increasing operational costs.

Financial Risks

Debt Obligations: As of September 30, 2024, the company had $294.4 million in cash and cash equivalents, with up to $400 million available under the 2024 ATM program. However, reliance on debt financing to support operations and growth strategies poses a risk, particularly if market conditions worsen.

Interest Rate Fluctuations: The company’s revolving credit agreement is influenced by interest rates. With the transition from LIBOR to SOFR, there may be increased volatility in borrowing costs, affecting overall financial performance.

Strategic Risks

Acquisition Integration: The company has pursued acquisitions, such as the purchase of Gateway Supply Company, Inc. for approximately $4 million in cash and 280,215 shares of common stock. Successful integration of these acquisitions is critical for achieving projected synergies and growth. Failure to effectively integrate could lead to operational inefficiencies and financial underperformance.

Market Share Loss: The company’s market share can be impacted by competitors’ pricing strategies and new product introductions. For example, the gross profit margin declined to 26.2% from 26.7% year-over-year, reflecting pressures from competitive pricing.

Future Growth Prospects for Watsco, Inc. (WSO)

Future Growth Prospects for Watsco, Inc.

Analysis of Key Growth Drivers

Watsco, Inc. stands poised for growth driven by several key factors, including product innovations, market expansions, and strategic acquisitions. Notably, the company reported revenues of $5.86 billion for the nine months ended September 30, 2024, reflecting a 3% increase compared to $5.68 billion in the same period of 2023.

Future Revenue Growth Projections and Earnings Estimates

Analysts project continued revenue growth, with estimates suggesting that the company's revenues could reach approximately $7.5 billion by 2025, driven by an increase in HVAC equipment sales and market demand. The earnings per share are anticipated to stabilize around $11.00 in the coming fiscal year, maintaining a healthy trajectory despite current market fluctuations.

Strategic Initiatives or Partnerships That May Drive Future Growth

The company has executed a significant partnership with Carrier Global Corporation, enhancing its distribution capabilities. As of September 30, 2024, Watsco had a 38.4% equity interest in Russell Sigler, Inc., contributing to other income of $23.9 million for the nine months.

Competitive Advantages That Position the Company for Growth

Watsco benefits from a robust distribution network, with 689 locations as of September 30, 2024, and a strategic focus on e-commerce initiatives that cater to evolving customer preferences. This network enables them to respond quickly to market demands and maintain a competitive edge in the HVAC/R product sector.

In summary, Watsco's strategic focus on partnerships, market expansion, and innovation in HVAC/R products positions it well for future growth amid evolving market dynamics. The company's financial health and operational strategies are expected to facilitate continued revenue increases and maintain its competitive advantages in the industry.

Article updated on 8 Nov 2024

Resources:

• Watsco, Inc. (WSO) Financial Statements – Access the full quarterly financial statements for Q3 2024 to get an in-depth view of Watsco, Inc. (WSO)' financial performance, including balance sheets, income statements, and cash flow statements.
• SEC Filings – View Watsco, Inc. (WSO)' latest filings with the U.S. Securities and Exchange Commission (SEC) for regulatory reports, annual and quarterly filings, and other essential disclosures.