Watsco (WSO) Rides on Investment in Technology, Costs High

Continued investment in technology, robust unit demand, along with improved equipment pricing and sales mix bode well for Watsco, Inc. WSO. However, higher SG&A expenses, lower vendor incentives and seasonal factors raise concerns.

Let’s delve deeper into the other factors that substantiate its Zacks Rank #3 (Hold).

Catalysts Driving Growth

Watsco has been performing pretty well of late. The company’s solid performance was backed by higher unit demand in HVAC equipment, as well as improved pricing and sales mix. Most importantly, Watsco’s continued investment in technology, which is designed to revolutionize customer experience, also added to the positives. During the third quarter of 2018, the company recorded the highest sales and profits in history, given the positives.

As the digital era progresses, speed, productivity and efficiency will be more critical. Watsco is deploying technology that improves order fill rates with speed and accuracy. Given this, the company’s e-commerce sales have added more than 30% to the total sales during the third quarter.

In October, Watsco acquired Alert Labs, a technology company in Canada, which will help the company to grow its customer base and profitability. Moreover, the buyout will enable the company to leverage technology investment, enhance productivity and reduce costs. It is optimistic about its progress in the upcoming quarters.

Watsco has immense growth potential in the replacement market as well as heating equipment. While replacement market demand remains usually high in the second and third quarters, demand for heating equipment is usually the highest during the fourth quarter. Notably, during the first nine months of 2018, revenues increased 7% in the residential HVAC equipment, driven by higher unit demand, price and mix for replacement HVAC systems.

Causes of Concern

Shares of Watsco have declined 9.2% over the past year, underperforming its industry‘s fall of 1.4%. Also, earnings estimates for 2018 and 2019 have moved 2.9% and 3.2% south, respectively, over the past 60 days. The downside primarily stemmed from the company’s inability to lower fixed operating costs.

During the third quarter, operating profit declined $ 3 million in Florida locations on flat sales and $ 2 million in Mexico on lower revenues. In the first nine months of 2018, selling, general and administrative expenses grew 5.6% from the prior-year period, and are anticipated to reach approximately $ 25 million in the fourth quarter.

Additionally, fluctuations in sales are expected in the near term, primarily due to seasonal demand of residential air conditioners and heating equipment. The favorable or unfavorable impact will be based on the severity or mildness of weather patterns.
Stocks to Consider

Some better-ranked stocks in the Construction sector are Great Lakes Dredge & Dock Corporation GLDD, Altair Engineering Inc. ALTR and EMCOR Group, Inc. EME. While Great Lakes currently sports a Zacks Rank #1 (Strong Buy), Altair Engineering and EMCOR both carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Great Lakes, Altair Engineering and EMCOR’s 2018 earnings are expected to increase 111%, 23.1% and 20%, respectively.

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