Watsco’s Journey: From a Family Business to an Industry Leader

Watsco, Inc. (WSO) is the largest distributor of air conditioning, heating, and refrigeration equipment in the highly fragmented $64 billion North American HVAC/R market. With a network of nearly 700 locations across the U.S., Canada, Mexico, and Latin America, Watsco has established itself as a dominant force, serving over 375,000 owner-operators, technicians, and installers annually.

Watsco’s roots trace back to 1956 when it was incorporated in Florida. Initially operating as a family business, the company entered the HVACR distribution industry in 1989, recognizing the sector’s potential for growth and consolidation. Over the following decades, Watsco embarked on an ambitious expansion strategy, combining organic growth with strategic acquisitions to establish itself as the industry’s undisputed leader.

A pivotal moment in Watsco’s history came in 2009 when the company acquired an 80% controlling interest in Carrier Enterprise I, a joint venture with Carrier Global Corporation. This acquisition significantly expanded Watsco’s product offerings and market reach. Throughout the 2000s and 2010s, Watsco continued its growth trajectory, acquiring businesses such as Gateway Supply Company, Inc. in 2023 and Commercial Specialists, Inc. in 2024, further solidifying its market position and expanding its geographic footprint across the United States, Canada, Mexico, and Puerto Rico.

Financial Strength and Operational Efficiency

Watsco’s financial performance has been nothing short of impressive. In the most recent fiscal year (2023), the company reported revenue of $7.28 billion and net income of $536.34 million. Operating cash flow reached $561.95 million, while free cash flow stood at $526.48 million. The most recent quarter (Q3 2024) saw revenue increase by 1.6% year-over-year to $2.16 billion, with net income remaining flat at $171.03 million. Operating cash flow and free cash flow showed significant improvements, increasing by 10.3% and 11.1% respectively.

The increase in revenue was primarily driven by $37.5 million from newly acquired locations and $2.8 million from other locations opened in the past 12 months, partially offset by $2.6 million from closed locations. On a same-store basis, sales remained flat year-over-year.

Watsco’s strong cash position of $294.4 million, coupled with no outstanding debt on its balance sheet, provides significant financial flexibility. This has enabled the company to weather economic downturns and pursue strategic investments, including the development of industry-leading technological platforms.

Moreover, Watsco has demonstrated a relentless focus on operational efficiency. While selling, general, and administrative (SG&A) expenses increased by 2% year-over-year in the third quarter, they remained flat on a same-store basis. This optimization has allowed the company to maintain its profitability even in the face of challenging market conditions.

Embracing Technological Innovation

Watsco’s commitment to technological innovation has been a key driver of its success. The company has invested heavily in developing and scaling cutting-edge digital platforms, such as its e-commerce solutions and the OnCall Air contractor platform. These tools have not only streamlined operations but also empowered Watsco’s vast network of HVAC/R contractors, helping them to enhance productivity and better serve their customers.

As a result, Watsco’s e-commerce sales have surged, now exceeding $2.5 billion on an annualized basis, with active users growing faster than non-users. Additionally, the OnCall Air platform has generated $1.2 billion in sales for Watsco’s contractor customers in 2024, a 22% increase compared to the prior year.

Capitalizing on Regulatory Changes and Sustainability Trends

Watsco’s business model has proven to be resilient in the face of evolving industry regulations and sustainability trends. The recent implementation of energy efficiency mandates, such as the increase in minimum SEER ratings, has created opportunities for Watsco to drive sales of higher-efficiency HVAC systems. Furthermore, the upcoming transition to the next-generation A2L refrigerants, mandated by the American Innovation and Manufacturing Act, is expected to be a catalyst for growth, as Watsco collaborates with its OEM partners to facilitate a smooth transition for its contractor customers.

The company is optimistic about the opportunity presented by the A2L transition, noting that historically, regulatory changes have been positive for their industry and business. Pricing from OEMs for A2L refrigerant systems is expected to be in the range of 8-10% higher, potentially driving revenue growth.

Sustainability is at the core of Watsco’s operations, as the company’s focus on upgrading older, less efficient HVAC systems has resulted in an estimated 21.8 million metric tons of CO2e emissions being averted since 2020. This commitment to environmental stewardship not only aligns with global climate change mitigation efforts but also positions Watsco as a leader in the HVAC/R industry’s transition towards a more sustainable future.

Strategic Acquisitions and Partnerships

Watsco’s growth strategy has been further bolstered by its active pursuit of strategic acquisitions and partnerships. In 2024, the company acquired Commercial Specialists, Inc. (CSI), a distributor of HVAC products operating in Kentucky and Ohio, and Gateway Supply Company, Inc. (GWS), a plumbing and HVAC distributor with a strong presence in South Carolina and North Carolina.

These acquisitions have not only expanded Watsco’s geographic reach but also reinforced its commitment to partnering with entrepreneurial-minded businesses that share its vision for industry transformation. Watsco’s ability to seamlessly integrate these acquisitions and leverage its technological platforms has been a key differentiator, driving accelerated growth and market share gains.

Challenges and Risks

While Watsco has demonstrated remarkable resilience, the company is not immune to industry challenges. The ongoing disruptions in the global supply chain, coupled with the potential for economic volatility, could impact the availability and pricing of HVAC/R equipment. Additionally, Watsco’s reliance on a limited number of OEM partners introduces concentration risk, which the company has proactively addressed through collaborative initiatives aimed at regaining market share.

The company is currently working with OEM partners on co-investments to regain business and add new customers in certain markets that were disrupted in the past. While these efforts may have short-term impacts on margins, they are expected to strengthen Watsco’s market position in the long run.

Furthermore, the HVAC/R industry’s highly fragmented nature presents both opportunities and risks, as Watsco must navigate a complex competitive landscape while ensuring the successful integration of its acquired businesses.

Liquidity and Financial Position

Watsco’s strong liquidity position is a testament to its prudent financial management. With a cash balance of $294.35 million and a debt-to-equity ratio of just 0.04, the company maintains significant financial flexibility. This robust liquidity is further supported by a $600 million unsecured revolving credit facility, providing additional resources for growth and investment.

The company’s solid financial footing is further evidenced by its strong current ratio of 3.36 and quick ratio of 1.65, demonstrating its ability to meet short-term obligations comfortably. This financial strength allows Watsco to pursue growth opportunities, invest in technological advancements, and weather potential economic uncertainties without compromising its operational integrity.

Watsco’s ability to generate substantial free cash flow provides additional support for its growth initiatives and strategic investments. The company’s consistent dividend payments and share repurchase programs further demonstrate its commitment to delivering shareholder value while maintaining a strong balance sheet.

Product Segment Performance and Geographic Breakdown

Watsco operates in a single reportable segment – the distribution of air conditioning, heating, and refrigeration equipment, and related parts and supplies (HVACR) in North America. The company’s product lines and their contributions to total revenues are as follows:

HVAC Equipment accounted for 70% of total revenues in both 2024 and 2023. Sales of residential unitary compressor-bearing systems, the majority component of HVAC equipment, decreased 2% during the third quarter of 2024, reflecting a 1% decrease in average selling price and a 1% decrease in unit volume. Domestic sales of these systems remained relatively flat, with a 3% decrease in average selling price offset by a 3% increase in units. Commercial HVAC equipment sales increased 6% in the U.S. market and 12% in international markets during the third quarter, reflecting increased demand for higher-efficiency commercial HVAC systems.

Other HVAC Products, including parts, supplies, and accessories used to install, maintain, and repair HVAC systems, accounted for 25% of total revenues in 2024 and 26% in 2023.

Commercial Refrigeration Products, which includes equipment and systems used to store and display merchandise in the commercial refrigeration market, accounted for 4% of total revenues in both 2024 and 2023.

Geographically, Watsco operates primarily in the United States, Canada, Mexico, and Puerto Rico. In Q3 2024, the US accounted for 90.2% of total revenue, Canada 4.5%, and Latin America/Caribbean 5.3%.

Recent Performance and Outlook

Watsco produced record sales and net income for the third quarter of 2024. Year-to-date, their unit volumes have been positive, with ducted products down 1% but ductless products up double digits. October sales were up mid-single digits, driven by meaningful unit growth, and the company believes it has gained market share based on industry data and shipment trends.

For the year-to-date period, Watsco’s unit volumes are up 5%, and unitary pricing is up 1%. The company remains optimistic about its future prospects, particularly with the upcoming transition to A2L refrigerants, which is expected to drive growth and potentially improve margins.

Gross profit margins declined 50 basis points to 26.2% in the third quarter of 2024 compared to the same period in 2023, primarily due to the impact of pricing and sales mix for HVAC equipment. The company estimated that marketing activities to regain sales and market share lost in 2023 due to constrained inventory availability from a key OEM partner were dilutive to gross margin by approximately 30 basis points for the nine months ended September 30, 2024.

Conclusion

Looking ahead, Watsco remains well-positioned to capitalize on the industry’s transformation. The company’s debt-free balance sheet, entrepreneurial culture, and technological prowess position it as a formidable player in the HVAC/R distribution landscape. As regulatory changes and sustainability trends continue to shape the industry, Watsco’s focus on providing energy-efficient solutions and supporting its extensive network of contractors will be crucial to its long-term success.

Watsco’s proven track record of navigating industry challenges, driving operational efficiency, and spearheading technological innovation makes it a compelling investment proposition for investors seeking exposure to the HVAC/R sector’s resilient and evolving landscape. With its strong market position, financial stability, and strategic focus on high-efficiency HVAC systems that support energy savings and reduced carbon emissions, Watsco is well-equipped to continue its growth trajectory and maintain its leadership in the North American HVACR distribution market.

Disclaimer: This article is for informational purposes only. It does not constitute financial, legal, or other types of advice. While every effort has been made to ensure the accuracy of the information presented here, the author and the publisher do not make any guarantees about the completeness, reliability, and accuracy of this information.