Watsco Inc. (WSO) recently reported its third quarter results. The company posted net income of 71 cents per share, in line with the Zacks Consensus Estimate, but 15.5% lower compared to last year.

The company’s total revenue was up 56.1% year-over-year $741.9 million. The current year quarter included $337 million of revenues added by Carrier Enterprise, a joint venture formed on July 1, 2009 with Carrier Corporation. The joint-venture added 95 locations to the Watsco network.

On a same-store basis, Watsco’s sales fell 15% compared to the third quarter of 2008. The sales decline was driven by lower demand as a result of economic conditions, lower pricing for certain commodity-based products, and significant weakness in the company’s western operations. These factors were partially offset by a richer sales mix of high-efficiency air conditioning systems.

Third quarter’s same-store sales reflect a 9% decline in sales of air conditioning and heating (HVAC) equipment, a 24% decline in sales of other HVAC products and a 17% decline in sales of refrigeration products.

The rapid decline in housing starts is being a drag on overall unit demand. We expect the housing market to remain challenging for the next couple of quarters. Thus, the company depends more on the replacement market for its top-line growth.

Watsco continues to benefit immensely from the transition to higher-efficiency air-conditioning equipment. The company said that the increased unit sales in this product category (at higher prices) generated 51% sales growth over last year. High-efficiency air conditioning systems sales represented 30% of the company’s unitary equipment sales during the third quarter.

The company sees huge potential in the replacement market as old units get replaced by more energy-efficient units in the coming years. Also, the company will benefit from the new economic stimulus legislation providing tax credits to homeowners for adding high-efficiency air conditioners or furnaces. We view the transition to higher energy-efficient units as the most critical factor for growth over the next couple of years. Higher efficiency units drive higher pricing and higher margins for the company.
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