We have upgraded our recommendation on Watsco Inc. (WSO) from Neutral to Outperform to reflect the gains in revenue and margin from the successful Carrier Canada deal. The quantitative Zacks #1 Rank (short-term Strong Buy rating) for the company indicates upward pressure on the stock over the near term.
To elaborate, Watsco has acquired Carrier’s HVAC (heating, ventilation and air conditioning) distribution network in Canada. The business will be operated as a 60:40 joint venture under the name Carrier Enterprise Canada.
Carrier’s Canadian distribution network encompasses 35 locations catering to 5,000 customers. It generated revenues of $330 million in 2011. Following the transaction, Watsco’s annual revenue will go up to $3.4 billion.
The company continues to increase its market share through strategic acquisitions and expansion of its product offerings. The company’s earlier joint-ventures with Carrier not only added new products to its sales mix, but also marked Watsco’s entry into the international markets with the addition of Latin American and Caribbean sales operations.
The company sees huge potential in the replacement market as old units are replaced by more energy-efficient ones in the coming years. There are approximately 89 million central air conditioning and heating systems installed in the United States that have been in service for more than 10 years, with the older systems operating below government mandated energy efficiency and environmental standards.
Watsco is positioned to benefit as an aging installed base of equipment gets replaced by newer high efficiency equipment. Moreover, these upgraded units drive higher pricing and margins for the company.
Watsco has also hiked its quarterly annual dividend by 9% to 62 cents, maintaining its streak of dividend increases for 11 consecutive years. This has been made possible by Watsco’s sound balance sheet and cash position.
The company’s debt-to-total-capitalization ratio is at a low of 5%. With current outstanding debt of $42.5 million, the company has substantial flexibility to make additional investments going forward. Backed by its strong balance sheet and recent success with Carrier joint ventures, the company is planning additional investment opportunities.
Watsco is the largest distributor of air conditioning, heating, and refrigeration equipment as well as related parts and supplies in the United States. It distributes residential and commercial air conditioners; parts such as replacement compressors, evaporator coils and motors; as well as supplies such as thermostats, insulation materials, refrigerants, grills, registers, sheet metal, tools, concrete pads, tape and adhesives.
Watsco distributes products from 541 locations to over 50,000 customers in 38 states, Puerto Rico, Latin America and the Caribbean. The company sources supplies from main industry players including Rheem, Carrier, Nordyne, Goodman, Trane and Lennox. The company competes with Johnson Controls Inc. (JCI) and privately held Gensco Inc.
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