Watsco: A Great Company At A Lofty Price

Apr. 26, 2022 8:12 AM ETWatsco, Inc. (WSO)BZLFF, BZLFY, CARR, MSM, SITE, UNVR, WCC, WCC.PA, WSO.B2 Comments3 Likes

Summary

  • Watsco has done incredibly well in recent years from a fundamental perspective, with revenue, profits, and cash flows gradually improving over time.
  • The long-term outlook for this firm is likely favorable, but there are concerns regarding pricing.
  • In the best case, the stock looks fairly valued, while a downturn in financial performance could make the stock overpriced quickly.
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Though the term ‘connected home’ is often associated with the integration of smart appliances and other gadgets (ones that collect data and analyze it for some specific purpose) to our homes, the origin of this development dates back to the 1800s when the first utilities were established. This enabled the creation of the original connected devices such as air conditioners, heating equipment, and refrigeration equipment. Today, the largest distributor of these types of technologies is Watsco (NYSE:WSO), a firm that services both residential and commercial end uses. Over the past few years, management has done extremely well to grow the company's top and bottom lines. Long term, this trend is likely to continue. Having said that, this does not mean that the company makes for a great prospect right now. Given how pricey shares are relative to similar firms, plus how lofty they look on an absolute basis, the company, while not probably overpriced, is definitely not a value play to consider right now.

A Play On Important Appliances

As I mentioned already, Watsco is dedicated to the sale of air conditioning, heating, and refrigeration equipment. On the HVAC side of the business, the company sources its products from 20 different vendors. Combined, sales of this type of equipment accounted for 69% of the company's overall revenue last year. Meanwhile, sales of other HVAC-related products, taken from roughly 1,200 vendors, comprise about 28% of the company's revenue. The business also sells commercial refrigeration products from about 140 vendors, representing 3% of overall revenue. Geographically speaking, 90% of the company's sales come from the US. A further 6% is attributed to Canada, while the remaining 4% has been chalked up to Latin America and the Caribbean.

In terms of its overall network, the company said that it had 671 stores in operation at the end of 2021. These stores are spread across states, as well as Canada, Mexico, and Puerto Rico. Some of its products are also exported to other parts of Latin America and the Caribbean. The area of largest concentration for the company is Florida, where it operates 103 stores. This is followed by Texas at 88 and North Carolina at 48. In Canada, meanwhile, the company has just 36 locations. 12 are in Mexico, and another twelve are in Puerto Rico. The company also has established multiple joint ventures over the years, the most recent of which was formed with Carrier Global Corporation (CARR) in 2012.

Watsco Historical Financials

Author - SEC EDGAR Data

Over at least the past five years, Watsco has done well to grow its top line. In each of the past five years, revenue increased, rising from $4.34 billion in 2017 to $6.28 billion in 2021. This translates to an annualized growth rate of 9.7%. What's really impressive is that growth was strongest between 2020 and 2021, when sales jumped a whopping 24.2% year over year. According to management, much of the company's increased sales in recent years has come from a rise in the number of stores it operates. Back in 2017, the business had 560 locations in operation. Today, that number is 671. Between 2020 and 2021 alone, it added 71 stores to its footprint, much of this achieved through acquisitions. It would also be accurate, however, just say that price increases also helped recently. For instance, for its residential unit airy air conditioner equipment, overall pricing rose by 9% in 2021. These same factors were also instrumental in the company continuing to grow its sales in the first quarter of the 2022 fiscal year. Revenue during this time frame came in at $1.52 billion. That is 34.1% higher than the $1.14 billion generated just one year earlier.

Watsco Q1 2022 Historical Financials

Author - SEC EDGAR Data

As revenue has risen, so too has profitability. Over the past five years, net income at the company expanded, climbing from $208.2 million in 2017 to $418.9 million last year. Higher pricing seems to have helped the company's bottom line drastically, as evidenced by the fact that profits, just one year earlier, totaled $269.6 million. Of course, there are other profitability metrics to pay attention to. One of these is operating cash flow. Interestingly, however, cash flow has been more volatile for the business. After falling from $306.5 million in 2017 to $170.6 million one year later, it began a drastic incline, eventually peaking at $534.4 million in 2020. Then, in 2021, it plunged to $349.6 million. If, however, we adjust for changes in working capital, the picture would look different. The metric would have declined from $282.5 million in 2017 to $170.6 million in 2018. After that, it began a consistent incline, eventually hitting $551.3 million in 2021. Meanwhile, EBITDA for the company has also been on the rise, growing from $372.9 million in 2017 to $637.6 million last year.

Watsco Store Count

Author - SEC EDGAR Data

This bottom line performance continued in the first quarter of the company's 2022 fiscal year. For that quarter, net profits came in at $113.3 million. That compares to the $50.3 million generated just one year earlier. Operating cash flow for the company actually worsened, going from a negative $37.7 million to a negative $101.6 million. If, however, we adjust for changes in working capital, it would have grown from a positive $80.8 million to $155.6 million. At the same time, EBITDA for the company also grew, rising from $84.1 million to $178.1 million.

WSO Stock Trading Multiples

Author - SEC EDGAR Data

Valuing Watsco is a pretty straightforward process. Due to inflationary pressures, I am hesitant to assume that results achieved in 2021 and so far for 2022 represent the new normal. Because of this, I decided to look at the company through the lens of both its 2021 and 2020 fiscal years. Doing so, we find a drastic difference in pricing for the enterprise. On a price-to-earnings basis, using the company's 2021 results, we see it trading at a multiple of 27. That compares to the 41.9 reading that we get if we rely on 2020 results. The price to adjusted operating cash flow multiple is 24. That compares to the 36 that we get if we rely on 2020 figures. And the EV to EBITDA multiple is 18.7. That compares to the 28.6 we get if we rely on 2020 figures.

Company Price / Earnings Price / Operating Cash Flow EV / EBITDA
Watsco 27.0 24.0 18.7
Bunzl (OTCPK:BZLFY) 21.6 13.1 12.1
SiteOne Landscape Supply (SITE) 28.6 32.3 16.8
WESCO International (WCC) 16.0 97.2 10.9
Univar Solutions (UNVR) 11.4 18.1 8.1
MSC Industrial Direct (MSM) 16.2 29.4 11.8

To put the pricing of the company into perspective, I decided to compare it to five similar firms. On a price-to-earnings basis, these companies ranged from a low of 11.4 to a high of 28.6. Four of the five companies were cheaper than Watsco in this respect. Using the price to operating cash flow approach, the ranges from 13.1 to 97.2. In this scenario, two of the five companies were cheaper than our target. And finally, we have the EV to EBITDA approach. That gives us a range of 8.1 to 16.8. In this case, our prospect is the most expensive of the group.

Takeaway

Based on all the data provided, Watsco strikes me as a fundamentally healthy company with a great past and a bright future ahead for it. I have no doubt that management will continue to generate value for its investors over the long haul. Having said that, shares of the company are not exactly cheap. I would not go so far as to say the company is overpriced. Though that may be the case relative to comparable firms. On the whole though, I would say that the stock is probably closer to being fairly valued. But in the event that recent upside achieved by the company is temporary because of extreme market conditions, I could see the stock ending up overpriced rather quickly. So because of that, investors would be wise to keep a close eye on the firm moving forward.

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This article was written by

Daniel Jones profile picture
22.71K Followers
Robust cash flow analyses of oil and gas companies

Daniel is currently the manager of Avaring Capital Advisors, LLC, a registered investment advisor that oversees one hedge fund, and he runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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