When companies announce record results, it's usually great news for investors, and Watsco (NYSE: WSO) has had a history of putting up unprecedented numbers from its HVAC system business. After a troubling set of quarterly results three months ago, Watsco investors came into Tuesday's third-quarter report looking for the company to get its sales and earnings moving back in the right direction. The heating and cooling specialist did manage to return to growth, but the pace of that growth wasn't quite what shareholders had hoped to see. Let's look more closely at how Watsco did and whether better times could be coming.
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Watsco deals with a slow summer
Watsco's third-quarter report gave investors only part of what they had wanted to see from the HVAC specialist. Revenue climbed 5% to $1.24 billion, but that was short of the 7.5% growth rate that most of those following the stock had wanted to see from Watsco. Similarly, net income climbed 9% to $63.1 million, yet the $1.78 per share in earnings that the figure translated into was $0.16 per share less than the consensus forecast among investors.
A closer look at Watsco's report reveals that many of the company's key metrics improved from poor performance in the second quarter but still remained less than robust. Same-store sales rose 6%, easily topping last quarter's flat performance. The ratio of overhead expenses to sales fell to a record low, and that helped boost operating margin to a third-quarter record of 9.6%. Operating income also reached new record levels during the quarter.
Among Watsco's three main segments, results were again mixed. Sales of HVAC equipment were up 7%, rebounding from a 1% decline in the previous quarter. Sales of other HVAC products posted only a 2% increase, failing to earn back the 3% decline in the second quarter. The commercial refrigeration products market, which is small and makes up just 5% of Watsco's total sales, gained 7%, slowing from last quarter's growth.
Watsco CEO Albert Nahmad tried to put the results in context and pointed to signs of improvement. "Growth trends improved in the quarter," Nahmad said, "after a slower than typical start to our summer selling season." The CEO highlighted the fact that high-efficiency systems did particularly well, with a well-balanced mix between the residential and commercial markets. In addition, efficiency has been important, and Nahmad noted that "we have made progress from our recent technology launch designed to enhance inventory turns."
What's ahead for Watsco?
Watsco is counting on its technological innovation to keep customers happy and make it more convenient for them to buy its products. Mobile apps and other online tools have made it easier for Watsco to serve its customers through e-commerce channels, which are growing rapidly. Watsco is also providing business intelligence and data analytics to help people make better decisions, and optimizing its supply chain has already produced some visible gains in efficiency. Overall, the company is enthusiastic about its technology efforts and thinks that they should bear fruit in stronger financial performance.
Yet Watsco investors weren't happy with the guidance that the company gave for the remainder of the year. Watsco said that it expects full-year earnings to come in between $5.15 and $5.20 per share, which is well below the current $5.34 per-share consensus forecast among analysts following the stock. The HVAC specialist offered no color on the figure, simply noting that it still expects cash flow to be higher than net income and therefore be able to finance dividend payments effectively.
The combination of tepid growth and lackluster guidance disheartened Watsco investors, and the stock fell 8% by midday following the announcement. Until the company can return to its stronger pace of growth, Watsco might have trouble convincing shareholders that better times still lie ahead.
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