Watsco Inc. ( WSO ) reported record earnings of $1.60, an 8% increase year over year, in the second quarter of 2014. Robust unit growth, a stronger sales mix of high-efficiency HVAC equipment, improved selling margins and operating efficiencies led to the outperformance. The reported figure however fell short of the Zacks Consensus Estimate of $1.70. Shares of Watsco have fallen 5% since reporting the results on Jul 17 as the market reacted to a lower than expected fiscal 2014 guidance.
Total revenue increased 4% year over year to a record $1.17 billion, but missed the Zacks Consensus Estimate of $1.2 billion. Sales of HVAC (heating, ventilation, and air conditioning) increased 7% while sale of other HVAC products increased 3%. Residential air conditioning and heating (:HVAC) equipment sales rose 6% and other HVAC product sales were up 2%. U.S. residential HVAC equipment sales increased 10% with gains in market share and commercial refrigeration products (5% of sales) sales increased 4%.
Cost and Margins
Cost of sales increased 4% year over year to $891 million. Gross profit grew 5% year over year to $279 million. Gross margin increased 10 basis points (bps) to 23.9% from the year-ago quarter.
Selling, general and administrative expenses rose 3% year over year to $166.2 million. Income from operations increased 8% year over year to a record $113 million. Operating margin increased 30 bps to a record 9.7%.
Cash and cash equivalents were at $16.9 million as of Jun 30, 2014, down compared with $19.5 million as of Dec 31, 2013. Cash flow used in operating activities was $65 million in the first half of fiscal 2014, compared with cash usage of $77 million in the prior-year quarter. The company’s debt-to-total-capital ratio was 23% as of Jun 30, 2014, up from 17% as of Dec 31, 2013. In April, Watsco announced a 50% increase in annual dividend to $2.40 per share.
In July, Watsco raised its stake in Carrier Enterprise LLC, a joint venture with Carrier Corporation, to 80% from 70% for about $90 million. Carrier is a leader in high technology heating, air-conditioning and refrigeration solutions. It is a unit of United Technologies Corp. ( UTX), a leading global provider to aerospace and building systems industries.
Watsco provided 2014 earnings per share guidance in the range of $4.20 to $4.40 per diluted share. This reflects annual growth of 14% to 20%.
Watsco has immense potential in the replacement market, given an aging stock of air conditioners and heating systems in the U.S. Watsco’s joint venture with Carrier Corporation continues to generate profits.
In addition to continued consolidation of the North American HVAC industry, Watsco continues to increase its market share through strategic acquisitions and expansion of its product offering and logistical, and productivity improvements.
Notably, the market for residential central air conditioning, heating and refrigeration equipment and related parts and supplies in the Americas is worth around $35 billion. Watsco now owns 10% of the market share and has immense potential to increase the same as no other competitor can match its geographic footprint.
Watsco currently has a Zacks Rank #3 (Hold). Some better-ranked stocks in the same sector include Comfort Systems USA Inc. ( FIX) and Arrow Electronics, Inc. ( ARW). Both of the stocks hold a Zacks Rank #2 (Buy).