September 13, 2011

Watsco, Inc. 

 

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based on our estimates—which we believe reflects both the Company’s operating skills and the absence of 

competing bidders given its unique position.  

Going forward, we believe additional operating improvements from the Carrier JVs, which expand 

Watsco’s revenue base by >60%, as well as the exercise of options to increase the Company’s ownership in 

the Carrier Sunbelt JV, should drive outsized earnings growth. Additionally, unitary equipment sales are 

currently at historic lows but should see a boost from the run-down of pent-up replacement demand and/or a 

recovery in new home construction levels. Even while discounting a full recovery by 2014 in our forecasts, we 

estimate Watsco’s intrinsic value at $75 per share based on 9x 2014E EV/EBITDA. Watsco also offers an 

unleveraged balance sheet ($65 million in seasonal borrowing) and strong free cash flow generation with an 

emphasis on returning cash to shareholders via dividends. The Company has increased its dividend rate for 10 

consecutive years, most recently by 10% to $2.28/share in February, offering an attractive 4.0% yield at the 

current share price. 

Industry Background 

The domestic residential and light commercial heating, ventilation, and air conditioning (HVAC) 

business is in many ways little changed looking back over the past fifty-plus years. On the supply side, while 

some low-cost Asian manufacturers have made modest headway into pockets of the industry, the HVAC 

equipment market is still dominated by a small number of original equipment manufacturers (OEMs) including: 

Trane (acquired by Ingersoll Rand in 2008), Carrier (United Technologies), York (Johnson Controls), Rheem 

(Paloma Industries), Lennox International, and Goodman Holding. The HVAC parts and supplies 

manufacturing business is more competitive, with hundreds of companies manufacturing various products. 

While several of the HVAC OEMs have company-owned distribution facilities, they represent a minority of 

industry sales. Several factors have kept factory-owned distribution centers to a minimum including the lack of 

specialized retailing/local customer relationship skills, capital allocation priorities, and the inability to offer a 

competitive/full slate of equipment, parts and supplies. Instead, the HVAC distribution business features 

greater than 1,300 separate independent distributors throughout the country.  

HVAC distributors sell to a wide, unconsolidated base of over 100,000 contractors. As a result, local 

relationships with individual contractors are key business drivers for distributors. Additionally, OEMs typically 

grant exclusive or semi-exclusive, often perpetual licenses to distributors on a regional or state-by-state basis. 

These licenses are typically not transferrable without the approval of the OEM and serve to control quality as 

well as to create a more rational pricing environment. As a result, many of the HVAC distributors are small local 

businesses that have been run by the same families for decades. These factors also serve as a barrier of sorts 

from the major do-it-yourself or big box retailers entering the business, while also making it more difficult for 

private equity money to quickly roll-up the distribution industry.  

Watsco History 

Watsco is the leading distributor of heating, ventilation, air conditioning, and refrigeration (HVAC/R) 

equipment and supplies in the United States. Watsco was founded in 1947 as a manufacturer of parts and 

supplies for heating, ventilation, and air conditioning systems. The Company went public in 1962 and in 1973 

came under the leadership of current Chairman, President and CEO and controlling shareholder Mr. Albert 

Nahmad (age 70). Watsco transitioned toward the distribution side of the HVAC/R business in 1989. Seeing a 

highly fragmented distribution business, over the next 20+ years, CEO Nahmad headed the acquisition of 57 

separate HVAC/R companies, primarily independent ‘mom and pop’ distributors. In 2009, Watsco established a 

transformational joint venture with leading HVAC equipment manufacturer Carrier Corp. (a subsidiary of United 

Technologies) to take over Carrier’s 95 distribution centers in the U.S. Sunbelt region. This year the joint 

venture was extended to Carrier’s Northeastern U.S. and Mexico operations. Under Mr. Nahmad’s leadership, 

Watsco has grown from approximately $25 million in annual sales in 1988 to a current run rate of roughly 

$3 billion across 526 distribution centers in 37 states. Watsco’s leading position in the industry still represents a 

modest ~10% market share and was built up through a very slow, methodical expansion and strategy of 

acquiring well-run local businesses over the past 20+ years. 

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Watsco, Inc. 

 

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Watsco’s Competitive Advantages  

Given the aforementioned industry dynamics, we believe HVAC/R distribution offers a relatively stable 

business for existing competitors with a limited threat from new entrants. In addition, we believe Watsco offers 

particular competitive advantages that should insulate it from significant market share erosion from fringe 

competitors:  



  Exclusive distribution agreements—Watsco holds exclusive distribution agreements in various 

regions with top OEMs such as Carrier and Rheem. This makes Watsco the only option for 

contractors looking for particular high-end products.   



 

Market Share—Although the Company’s leading market share still accounts for only approximately 

10% of the $30 billion domestic market, management has noted that Watsco maintains 20%-30% 

or greater market share in many of its top regions. Watsco’s scale and market share also provide it 

with an advantage in negotiation power with suppliers compared to smaller independents.  



 

Customer relationships—Watsco supplies to over 50,000 contractors. A very local customer base 

and Watsco’s focus on retaining long-tenured store managers and counter people creates a sense 

of loyalty. Watsco also offers customers assistance with local advertising, market development and 

strategy, which few competitors match.   



 

Balance Sheet Size & Strength—Watsco is by far the largest HVAC/R distributor, and also sports a 

healthy balance sheet (net debt to EBITDA only 0.2x). When smaller family distributors are looking 

to exit the business, Watsco is the best-capitalized, and sometimes the only, potential buyer. This 

has historically allowed the Company to acquire profitable, well-run businesses at attractive 

valuations. Watsco’s balance sheet also enables the Company to extend credit to its customers, 

which may help win business from competitors. According to the Company, the average customer 

has roughly $5,000 in credit. Allowance for doubtful accounts were still modest at $6.3 million at 

year-end 2010.  

Watsco Business Description & Recent Performance 

Watsco operates 526 distribution facilities across 37 states and Puerto Rico. The Company has 

historically concentrated on gaining scale in the ‘Sunbelt’ region across the southern U.S., where central air 

condition is more often seen as a necessity and seasonality in the business is minimized. The Sunbelt still 

accounts for close to 90% of the Company’s revenue, including close to 30% from Florida and between 

15%-20% from Texas, with the Carolinas accounting for the third-greatest share. With the recent Carrier 

Enterprise joint ventures (described in greater detail on pages 68), Watsco is also expanding its reach in the 

Northeast as well as Latin America and the Caribbean.   

 

Note: Watsco locations in white, Carrier Enterprise locations in black 

Source: Company presentation, August 2011 

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