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Is Watsco (WSO) A Smart Long-Term Buy?

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LRT Capital Management, an investment management firm, published its third-quarter 2021 investor letter – a copy of which can be downloaded here. A return of +18.39% was recorded by the LRT Economic Moat strategy year-to-date, extending its 12-month returns to +35.34%. You can take a look at the fund’s top 5 holdings to have an idea about their best picks for 2021.

LRT Capital Management, in its Q3 2021 investor letter, mentioned Watsco, Inc. (NYSE: WSO) and discussed its stance on the firm. Watsco, Inc. is a Coconut Grove, Miami-based HVAC company with an $11.6 billion market capitalization. WSO delivered a 32.53% return since the beginning of the year, while its 12-month returns are up by 34.19%. The stock closed at $300.24 per share on November 26, 2021.

Here is what LRT Capital Management has to say about Watsco, Inc. in its Q3 2021 investor letter:

"Watsco is a long time holding of our fund that recently made it into the top ten. The company distributes Heating Ventilation and Air Conditioning equipment (HVAC). The HVAC distribution business is approximately 80% replacement / 20% new construction. This is a great business due to the fragmented supplier base (seven major HVAC manufacturers) and fragmented buyers (thousands of HVAC contractors). This limits the bargaining power of both buyers and suppliers. Furthermore, while homeowners ultimately pay the bill, in most cases it is the contractor that makes the purchasing decision. Parts availability, speed of delivery and ease of installation play a major role in the purchasing decision with price being only a secondary consideration. Most HVAC equipment is bulky and difficult to ship – limiting competition from online players. Simply put, when your HVAC unit breaks on a hot summer weekend you don’t spend time shopping around for the lowest price – fixing the AC unit becomes a priority no matter the cost. The company’s earnings are also extremely predictable given that the majority of sales are tied to replacement demand which itself is a function of the installed base.

Watsco is the largest player in a very fragmented industry. The company earns mid-teens returns on invested capital and pays out the majority of earnings in the form of dividends. The company also expands through acquisitions over time, buying up smaller independent HVAC distributors. Most recently they have acquired Temperature Equipment, a Chicago based distributor59. Watsco also has the most unique longterm compensation policy for senior executives we have ever come across in corporate America – all stock grants vest at retirement or after 10 years, whichever comes later. This makes managers extremely longterm focused, something we believe is a real benefit for a company that grows primarily through acquisitions.

Watsco last reported earnings on July 22nd, beating both top (EPS +64% YoY) and bottom-line estimates. The company also raised its dividend in conjunction with reporting earnings60. We believe the shares are attractive at current valuations given the extremely predictable earnings the company enjoys, recession proof nature of the product and long growth runway. GAAP earnings are understated due to the amortization of intangible assets related to prior acquisitions. Shares are +20.57% year-to-date and +19.16% over the past twelve months."

HVAC, Aircon
HVAC, Aircon

taylor-vick-VXf6Nb_UfpQ-unsplash

Based on our calculations, Watsco, Inc. (NYSE: WSO) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. WSO was in 30 hedge fund portfolios at the end of the third quarter of 2021, compared to 26 funds in the previous quarter. Watsco, Inc. (NYSE: WSO) delivered a 9.00% return in the past 3 months.

Disclosure: None. This article is originally published at Insider Monkey.