Watsco (WSO) Gains From Technologies Amid Inflationary Woes

·4-min read

Watsco, Inc. WSO is poised to benefit from its continuous investment in industry-leading technologies, accretive acquisitions and a consistent focus on rewarding shareholders. Its gradual transformation from manual processes to a completely digital platform is an added positive.

However, intense inflation, supply-chain disruption and labor woes have been impacting the construction sector. Apart from these, Watsco is investing a heavy amount in technology deployment, which is ultimately increasing costs. Seasonality and competitive pressure are other concerns.

Let’s Delve into Driving Factors

Investment in Technology: Watsco boosted its annualized technology spending in 2022 by 14% to $49 million. As the digital era progresses, speed, productivity and efficiency will be more critical. On that note, Watsco is investing in technologies to improve customer experience through e-commerce. It is using various new technologies to transform the homeowner experience, which will help the company expand its customer base.

Currently, it has the industry’s largest database of digitized product information, with nearly 1 million SKUs being used by more than 350,000 technical contractors and technicians annually via the Product Information Management database. Also, its HVAC Pro+ Mobile apps provide customers with real-time access to critical information that improves their speed and productivity. The authenticated user community grew 20% as of 2022-end to more than 51,000 users.

E-Commerce Drive: Driven by various technology platforms, e-commerce sales were up 17% at the end of 2022 from the year-ago period. E-commerce sales outpaced $2.3 billion for the trailing 12-month period and accounted for 32% of the total sales, inclusive of acquired revenues.

Additionally, Watsco’s digital sales platform for HVAC/R contractors and CreditForComfort (its companion consumer financing platform) — OnCallAir — generated $939 million in gross merchandise value in 2022, reflecting a 49% year-over-year increase.

Solid Liquidity & Rewarding Shareholders: Watsco has a strong balance sheet position and enough liquidity to manage the persistent crisis. The company ended 2022 with cash and cash equivalents of $147.5 million, reflecting an increase from $118.3 million at 2021-end.

Watsco has been paying cash dividends for 49 consecutive years. It has been consistently focusing on sharing its cash flows with shareholders and maintaining a strong financial position. The company increased dividends in 21 out of the last 22 years. In January 2023, it announced an annual dividend hike of 11% to $9.80 per share.

Hurdles

Higher Costs: Watsco has been affected by persisting inflation and supply-chain headwinds. In 2022, SG&A expenses increased 15% year over year due to the pandemic-related business challenges and sharp increases in variable operating expenses, including company-wide, performance-based compensation, excessive logistics and freight costs caused by supply-chain disruptions, and other inflationary impacts. Although earnings grew in the fourth quarter of 2022, its SG&A expenses increased 3.3% year over year.

Seasonal Sales: Sales of residential central air conditioners, heating equipment, and parts and supplies have historically been seasonal for Watsco and other companies like AAON, Inc. AAON, Comfort Systems USA, Inc. FIX and Lennox International Inc. LII.

Watsco’s profitability will be impacted favorably or unfavorably based on the severity or mildness of weather patterns during the summer or winter selling seasons. The company’s first and fourth quarters of each calendar is disproportionately affected by seasonality due to the nature and timing of HVAC systems replacement.

Historically, demand for the residential central air conditioning replacement market is comparatively low during the first and fourth quarters. Similarly, demand for heating equipment is generally impacted in the second and third quarters.

A Brief Discussion on the Other Companies

AAON’s fourth-quarter 2022 has been gaining from multiple price increases initiated throughout the year, reduced impacts from the supply chain and significant production efficiency improvements over all plant floors. The company continues to adapt quickly and maximize production despite the ongoing challenges of parts shortages.

AAON finished the fourth quarter of 2022 with a record backlog of $548.0 million, up 110.6% from $260.2 million on Dec 31, 2021. AAON has a trailing four-quarter earnings surprise of 5.7%, on average.

Comfort Systems ended 2022 with a solid backlog level of $4.06 billion, up from $3.25 billion as of Sep 30, 2022, and $2.31 billion as of Dec 31, 2021. On a same-store basis, the backlog increased from $2.31 billion as of Dec 31, 2021, to $4.03 billion as of Dec 31, 2022. The backlog level depicts the company’s ability to generate higher revenues in the future.

FIX has a trailing four-quarter earnings surprise of 9.9%, on average.

Lennox’s growth across all three segments (Residential, Commercial and Refrigeration) and solid execution on Commercial business profit recovery have been driving growth. The company has been implementing higher pricing to outpace the ongoing inflationary challenges.

LII has a trailing four-quarter earnings surprise of 5.7%, on average.

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