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Watsco Remains at Neutral

Zacks Equity Research

On Dec 5, we reiterated our Neutral recommendation on Watsco Inc. (WSO), a leading distributor of air conditioning, heating, and refrigeration equipment as well as related parts and supplies (HVAC/R) in the United States.

Why Reiterated?

Watsco reported 11% year-over-year improvement in third quarter 2013 earnings per share of $1.32 along with record revenues of $1.1 billion, up 6% year over year. Watsco revised its earnings per share guidance to $3.65-$3.70 from $3.60-$3.75. This implies annual growth rate of 20% to 22% over 2012. Watsco expects strong residential HVAC systems sales in the U.S., which grew in double digits, and an improved sales trend for commercial products. Watsco’s strong cash flow and healthy balance sheet will aid business growth.

Watsco will continue to benefit from the demand in the replacement market as old units would get replaced by more energy-efficient units in the coming years. There are approximately 90 million central air conditioning and heating systems installed in the United States that have been in service for more than 10 years. Moreover, higher efficiency units drive higher pricing and higher margins for the company.

Watsco’s joint venture with Carrier Corporation, a wholly-owned subsidiary of United Technologies Corp. (UTX), remains successful and continues to generate profits.  Watsco has an option to purchase an additional 10% interest in the Carrier joint venture in the Sun Belt region, which becomes exercisable in Jul 2014. This option, if exercised, is expected to be accretive to Watsco’s earnings.

Management outlined its long-term plans to increase revenues to above $10 billion and margins above 10%. This will be driven by organic growth initiatives including new product offerings, geographic expansion, and logistical, productivity improvements, in addition to continued consolidation of the North American HVAC industry.

However, data for housing starts is not available since September as the lapse in federal funding affected the data collection schedule. Housing starts rose in August, but only because July was revised down. The August starts annualized level of 891,000 units was up 19% year over year. July was revised down to 883,000 million units from the original estimate of 896,000 million. In June, housing starts had unexpectedly fallen to the lowest level in almost a year to 836,000 units. Recent rise in mortgage rates has made builders cautious about breaking ground on new projects. This puts a question on the expected recovery in the housing sector, which would have otherwise benefited Watsco.

Watsco has been historically acquisitive. The company stated that though it is focused on large acquisitions, but the lack of potential targets at present may restrict the company from buying any companies in 2013.

Other Stocks to Consider

Watsco currently carries a Zacks Rank #4 (Sell).  Some better-ranked stocks in the building products – air/heater sector include Comfort Systems USA Inc. (FIX) and Nortek Inc. (NTK). Both the stocks hold a Zacks Rank #2 (Buy).

Read the Full Research Report on WSO
Read the Full Research Report on UTX
Read the Full Research Report on FIX
Read the Full Research Report on NTK

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