Watsco’s Outlook: More M&A, Customer Focus, Tech Investment

Miami-based HVACR distribution giant Watsco sees 2021 as optimal for ramping up existing growth drivers in hopes of continuing at its record-setting pace.
Watsco 2020 earnings blog

Watsco Inc. has been operating out of the same playbook for the past few years, and in 2021 the Miami-based HVACR distributor expects to double down on the growth drivers that have been propelling the company to record sales, cash flow and profit.

Last week, the company reported 2020 sales of $5.1 billion, up 6% over 2019 and another record for annual revenue. Profit improved 9.6% to $269.8 million, also a record. Excluding acquisitions, HVAC equipment sales increased 4% in the year-to-date period, other HVAC products were flat and commercial refrigeration equipment decreased 4%.

For the fourth quarter, the company reported sales of $1.2 billion, up 7.7% year-over-year, and a profit increase of 23.4% to $46 million — both also records. Excluding acquisitions, Watsco’s HVAC equipment sales increased 9% in the quarter, other HVAC products increased 7% and commercial refrigeration equipment sales increased 2%.

On the subsequent earnings call, Watsco’s leadership shared some of their plans for the coming year as the company looks to leverage its market strength as well as favorable industry trends due to more people staying home amid the pandemic and therefore investing in their HVACR systems.

First, a broader look at the marketplace. Earlier this month, Heating, Air-conditioning & Refrigeration Distributors International (HARDI), released its monthly TRENDS report, showing the average sales performance by HARDI distributors was an increase of 21.4% during December. The average annual sales growth for 2020 was 4.1%.

Watsco, the No. 1 ranked company on MDM’s Top HVACR distributors list, is confident that the industry will “remain strong during the year,” according to Paul Johnston, the company’s executive vice president, on the earnings call.

“Replacement demand, we’re still seeing that following through with where we ended last year or beginning this year on the right footing,” Johnston said. “I think there’s another phenomenon out there that’s helping and changing the replacement dynamics, and that is we’re seeing homeowners stay in their homes for longer periods. I don’t mean because of the pandemic. They’re not flipping houses as they were in the early 2000s. We’re seeing them stay in their homes 13, 14 years, which is a good indicator that when something does happen to your air conditioning system, you’re probably going to replace it as opposed to repair it. You’d have more of a tendency to repair if you are planning to sell your home. So I’m bullish on that.”

What’s more, Johnston added, is that Watsco sees plenty of runway in its current markets to gain share, especially on the OEM side of the business.

Breaking Down the Drivers

The HVACR industry is trending positively for Watsco, but the distributor, as it has in recent years, isn’t waiting around. It’s pressing forward on such growth drivers as increased M&A, advanced digital transformation and enhanced customer acquisition. Let’s unpack each one to better understand the company’s approach to 2021.

M&A will be a focus for Watsco this year, according to CEO Albert “Al” Nahmad and EVP Barry Logan, each of whom spoke about growth through acquisitions on the earnings call.

“Watsco is an acquirer,” Nahmad said. “As part of our overall strategy, we have a $5 billion revenue in the $40 billion industry, so our share has a lot of room to grow, and we use our balance sheet to support M&A. We are active, and … there’s no promise, but we do think we’ll have M&A this year.”

Logan added, “We’re not attempting to roll up a fragmented industry. We’re focused on the largest of targets that will drive growth and share and then platforms to build on and invest in. The second, big picture fundamental is, we would rather invest in businesses when they’re growing and reaching greater strength. We’re not turnaround experts, we’re not looking for a dip in the market to buy. We’re looking to invest in strengthening businesses.”

Watsco also continues to invest in technology, noted Nahmad, who said the company’s mobile app users increased 27% in 2020, with more than 120,000 downloads, while e-commerce transactions grew by one-fifth to 1.2 million online orders.

“User growth on Watsco’s e-commerce platform, a good indicator of overall tech adoption, was up 20% during 2020,” he said. “This is important as sales growth rates for customers that are active users outpace growth rates of non-users. Also, customer attrition among active users is a fraction of non-users, another good indicator of effectiveness.”

That emphasis on technology leads nicely into Watsco’s customer acquisition efforts. The company said it continues to focus on finding new ways to bring new customers into the fold, something the company’s president (and Albert’s son) Aaron “A.J.” Nahmad alluded to on the earnings call, especially as it relates to the current supply chain constraints across the industry due to strong demand.

“Our technology enabled us to fill customer orders and take market share and show sales growth in that environment as well as it gave us new insight and tools to attack what we call non-performing inventory — inventory that’s probably been on our shelves for too long,” Nahmad said. “So with more detail and more talent focused on it, we were able to move some of that old product out of the network as well. So it’s a mix and a confluence of all three factors. And certainly, those efforts are going to continue going into 2021 and beyond.”

All of which adds up to an upbeat outlook for the company, according to Baird’s Dave Manthey in a note to clients. While he cautioned about normal HVACR cycles moderating earnings growth this year, there’s no doubt that Watsco’s future is bright as its recent past.

“WSO is the No. 1 independent distributor of HVAC equipment and supplies, through a combination of organic growth, acquisitions and joint ventures,” Manthey wrote. “We believe WSO will continue to take market share from the fragmented group of 1,300+ HVAC distributors in the U.S given benefits of scale (higher rebates, better sourcing, management resources, breadth of products, new technology tools, etc.), and driven by recent investment spending.”

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