Watsco (WSO) Shares Fall On Q3 Earnings & Revenue Miss

Shares of Watsco Inc. WSO plunged about 10.6% yesterday after the company’s third-quarter 2015 earnings per share of $1.64 missed the Zacks Consensus Estimate of $1.78. Earnings, however, were a record and increased 5% year over year driven by rise in sales, improved selling margins and expanded operating margins.

Total revenue in the quarter increased 4% year over year to a record $1.18 billion. Sales of HVAC (heating, ventilating and air conditioning) increased 5%, other HVAC products rose 3% and commercial refrigeration products increased 2%. However, revenues fell short of the Zacks Consensus Estimate of $1.20 billion.

Cost and Margins

Cost of sales increased 3.6% year over year to $891 million. Gross profit grew 4% year over year to $285.8 million while gross margin increased 10 basis points (bps) from the year-ago quarter to 24.3%.

Selling, general and administrative expenses (SG&A) rose 3.3% year over year to $175 million. Income from operations increased 5.2% year over year to a record $110.7 million. Operating margin increased 10% from the prior-year quarter to 9.4%.

Financial Operations

Watsco had cash and cash equivalents of $28.5 million at the end of third-quarter 2015 compared with $24.4 million at 2014-end. The company recorded cash flow from operations of $99.8 million for the nine months ended Sep 30, 2015, compared with $41.7 million for the nine months ended Sep 30, 2014.  

Watsco also approved a 21% increase in its annual dividend to $3.40 per share. The increase will be reflected in the company’s next regular dividend payment beginning in Jan 2016.

2015 Guidance

Watsco slashed its 2015 earnings per share outlook to the range of $4.85 to $4.90 from its previous guidance of $5.00 to $5.20. This represents an annual growth rate of 16% to 20%.

Watsco is aggressively investing in a number of scalable technologies. The goals of the strategy are to further strengthen Watsco’s leadership position in the marketplace, accelerate sales and profit growth through innovation, efficiency in serving customers and to expand in new geographies and sales channels.

Our Take

Watsco has immense potential in the replacement market given an aging stock of air conditioners and heating systems in the U.S. The company will benefit from expansion of its product offering as well as logistical and productivity improvements. Dividend hikes and share repurchases will be accretive to earnings. However, foreign currency headwinds, seasonal factors and lack of acquisitions will weigh on Watsco’s results.

Watsco currently has a Zacks Rank #3 (Hold). Other stocks in the sector worth considering are Acuity Brands, Inc. AYI, Gafisa S.A. GFA and Lennar Corporation LEN, all carrying a Zacks Rank #2 (Buy).

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