Company Review – Watsco, Inc.

Watsco, Inc. is a distributor of refrigeration, air conditioning, and heating equipment and supplies in the United States.  In this article we will review the business and management using Warren Buffett’s approach, then follow a modernized Benjamin Graham style of valuation to review the financial statements and value of the firm.  As always, our methods are outlined on our site.

Business and Management Review

1) Is the business simple and understandable?

Watsco is in the business of providing equipment and supplies to contractors.  The company operates out of over 360 subsidiary locations in 32 states, and currently serves over 38,000 contractors.  The nature of the business is simple – purchase the equipment from the manufacturers and distribute it to the contractors via the subsidiaries.  Essentially Watsco operates as a middleman for contractors. 

2) Does the business have a consistent operating history?

Watsco has always operated with a consistent business plan.  Today, over 99% of Watsco’s revenues come via its distribution segment.  We believe this is evidence of a focused and consistent business plan.  When the investor purchases a share of Watsco, the investor knows what he or she is purchasing – a distributor.

3) Does the business have favorable long term prospects?

Long-term, we believe Watsco is in good position.  With the housing market slumping, consumers will increasingly look to remodel their homes and improve their living quarters.  Watsco is in position to capitalize on that change in household positioning.  At the same time, when the housing market recovers, Watsco will be a solid provider for the contractors and home builders looking to manufacture new homes.  In our view, Watsco benefits from either a slump or a rise in the housing market.

4) Is management rational?

Management has done nothing to cause us to believe they operate in an irrational manner.  The company has performed well in the past, and as the management has remained fairly steady, similar performance can be expected in the future.

5) Is management candid with its shareholders?

Watsco does not have a very detailed website, but does provide all of the necessary and usual information on its Investor Relations page.  We would like to see the company provide more information about its history and strategy on its site for investors.

6) Does management resist the institutional imperative?

Albert Nahmad is the Chairman of the Board, President, and Chief Executive Officer of Watsco, and has held the position since 1973.  This long tenure, not to mention the company’s rise to the largest distributor of its kind, indicates that Mr. Nahmad has resisted the institutional imperative. 

Financial and Value Review

Defensive Investor:

1) Size of firm

Watsco’s market capitalization is $1.44 billion, below our $2 billion threshold for the defensive investor.

2) Strong financial condition

With a current ratio of about 2.75, Watsco passes this test.

3) Earnings stability

There has been stability in Watsco’s earnings through over 10 years of a positive net income.  Pass.

4) Dividend record

Watsco has paid a dividend for over 10 years so it passes this test as well.

5) Earnings growth

Over the last 10 years, earnings have grown more than 1/3.  Once again, Watsco passes the test.

6) Price to earnings analysis

Using an average of earnings over the last 5 years, Watsco’s PE is 28.8.  Since the defensive investor requires a PE ratio of under 20, the company fails this test.

7) Price to assets analysis

With a Price to book ratio of 2.82 and a combined PE and Price to book ratio (multiply PE by PB) of over 50, Watsco fails this test as well.

Overall

Watsco passed only 4 out of the 7 tests for the defensive investor, so the company is not suitable for investment by this type of individual.

 

Enterprising:

1) Strong financial condition

As stated above, Watsco has a strong current ratio, well above the enterprising investor’s target of 1.5.

2) Earnings stability

Having earned a positive net income for the last five years, Watsco passes this test.

3) Dividend record

Since the company simply pays a dividend, this test is passed.

4) Earnings growth

The company has grown earnings over the last 5 years, so it passes the final test for the enterprising investor.

Overall

Watsco passes all of the tests for the enterprising investor, and may be a suitable investment for the enterprising intelligent investor following Benjamin Graham’s value investing strategy.

 

Valuation:

Our valuation model determines a fair value of Watsco to be about $40.


Opinion:

Though Watsco is a strong company with good prospects and management, we do not feel that it is currently priced well for investment.  It is our opinion that Watsco is overvalued (though at a more attractive price this would be a very attractive company). 

Neither of us held a position in Watsco, Inc. at the time of publication.  Also, please read our disclaimer and Our Methods.

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