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Watsco Earnings Outperform, Shares Up

Shares of Watsco Inc. (WSO) have gained 5% and closed at $104.18, after reporting first-quarter 2014 results on Apr 17. Earnings per share increased 23% year over year to a record 48 cents from 39 cents in the year-ago quarter. The reported figure also beat the Zacks Consensus Estimate by a penny. The growth was aided by higher sales, stronger selling margins and improved operating efficiencies.

Total revenue increased 7% year over year to a record $763 million and surpassed the Zacks Consensus Estimate of $761 million. Residential air conditioning and heating (:HVAC) equipment sales rose 13% and other HVAC product sales were up 8%.

Cost and Margins

Cost of sales increased 6.7% year over year to $574.5 million. Gross profit grew 7% year over year to $188 million. Gross profit margin increased 10 basis points (bps) to 24.7% from 24.6% in the year-ago quarter. Selling, general and administrative expenses rose 5% year over year to $152.5 million. Income from operations increased 16% year over year to a record $35.6 million. Operating margin increased 40 bps to 4.7%.

Financial Operations

Cash and cash equivalents remained flat at $19.5 million as of Mar 31, 2014, compared with Dec 31, 2013. Cash flow from operating activities was $24.9 million in the reported quarter, compared with cash usage of $17.5 million in the prior-year quarter. The company’s debt-to-total-capital ratio was 17% as of Mar 31, 2014, flat as compared with Dec 31, 2013. Watsco also announced a 50% increase in annual dividend to $2.40 per share.

Our Take

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 (:JV) with Carrier Corporation, a wholly owned subsidiary of United Technologies Corp. (UTX), continues to generate profits. The company intends to purchase an additional 10% interest in the JV in the Sun Belt region in 2014. This is likely to be accretive to earnings.

Watsco currently has a Zacks Rank #2 (Buy). Some better-ranked stocks in the same sector include Nortek Inc. (NTK) and Arrow Electronics, Inc. (ARW). Both of these have the same Zacks Rank as Watsco.

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