Business Breakdowns
· Matt Reustle, Lucy Adams
[00:00:00] S0: I understand how transactions occur within the industry and where Watsco is acting within some of those transactions. How does that show up in the numbers in terms of how pricing is determined, how a margin is being considered for Watsco, and anything else that would go into how they're actually making money. [00:00:00] S2: Let's start with how it is making money. That's straightforward. They're purchasing equipment from the major manufacturers as well as parts and supplies from this long tail of other suppliers. Then they're selling those products to the contractors and adding a percentage markup. They're investing part of this markup to provide these additional services that we've talked about to the contractors. That's how it earns revenues. In terms of the size of the business today, it's generating over seven and a half billion dollars in sales, primarily in the US, with 90% of its sales coming from the US and the remainder split equally between Canada and Latin America. If we move on to the products that it sells, it groups these into three categories. Equipment generates 70% of sales, parts and supplies around 25%, and the remaining 5% is commercial refrigeration products. To complete that picture, in terms of the end markets that it serves, that's 80% residential and 20% commercial. Within that core residential market, around 80% is driven by repair and replacement, and 20% from new housing.
· Lucy Adams, Alan Murran, Matt Reustle
[00:00:00] S2: Let's start with how it is making money. That's straightforward. They're purchasing equipment from the major manufacturers as well as parts and supplies from this long tail of other suppliers. Then they're selling those products to the contractors and adding a percentage markup. They're investing part of this markup to provide these additional services that we've talked about to the contractors. That's how it earns revenues. In terms of the size of the business today, it's generating over seven and a half billion dollars in sales, primarily in the US, with 90% of its sales coming from the US and the remainder split equally between Canada and Latin America. If we move on to the products that it sells, it groups these into three categories. Equipment generates 70% of sales, parts and supplies around 25%, and the remaining 5% is commercial refrigeration products. To complete that picture, in terms of the end markets that it serves, that's 80% residential and 20% commercial. Within that core residential market, around 80% is driven by repair and replacement, and 20% from new housing. [00:00:00] S1: It's worth adding in there that new housing was around 30% of Watsco's total sales prior to the global financial crisis. As the installed base of HVAC units has increased, and with Watsco's growth in other areas like parts and supplies, this percentage is now smaller. That reduces some of the cyclicality risk in the business. [00:00:00] S0: That’s 70% of revenue being equipment. A large majority of that comes from replacement equipment and not necessarily new housing.
· Matt Reustle, Lucy Adams
[00:00:00] S0: That’s 70% of revenue being equipment. A large majority of that comes from replacement equipment and not necessarily new housing. [00:00:00] S2: That's right. [00:00:00] S0: Thinking about the trajectory of that revenue growth, you mentioned the acquisitions over the years and joint ventures. The carrier deal we touched on a little bit might be good to paint a bit more of a picture about that. How have they approached growth? Whether it's just an organic pricing-plus-volume model that's playing out, with occasional M&A, or how deliberate they are about M&A? More just in terms of the top line and expansion of the business.
· Matt Reustle, Lucy Adams
[00:00:00] S0: Thinking about the trajectory of that revenue growth, you mentioned the acquisitions over the years and joint ventures. The carrier deal we touched on a little bit might be good to paint a bit more of a picture about that. How have they approached growth? Whether it's just an organic pricing-plus-volume model that's playing out, with occasional M&A, or how deliberate they are about M&A? More just in terms of the top line and expansion of the business. [00:00:00] S2: We would expect organic revenues to grow at around 5%. Let's break that down between volume and price. If we start with volume, we have industry unit volumes growing at around 3 to 4%. Therefore we'd expect both equipment and parts to grow in line with that. Watsco tends to grow a little bit more, and that's a combination of market share gains and the fact that 60% of their network are in these faster-growing Sun Belt states. If we turn to price and mix, that adds a further 2 to 3% of growth each year. This is primarily driven by two things. First, we have the typical annual price increases by the manufacturers, so they typically realize a below-single-digit growth rate each year. Then we have a regulatory-driven mix impact every 10 years or so, and we smooth that out over time. If I add volume and price together, that gives us a 5% organic growth rate. There are other growth drivers that we've seen over the years. M&A is a key one, and it's opportunistic. If we smooth that out, we expect that to add another 2% to growth.
· Lucy Adams, Matt Reustle
[00:00:00] S2: We would expect organic revenues to grow at around 5%. Let's break that down between volume and price. If we start with volume, we have industry unit volumes growing at around 3 to 4%. Therefore we'd expect both equipment and parts to grow in line with that. Watsco tends to grow a little bit more, and that's a combination of market share gains and the fact that 60% of their network are in these faster-growing Sun Belt states. If we turn to price and mix, that adds a further 2 to 3% of growth each year. This is primarily driven by two things. First, we have the typical annual price increases by the manufacturers, so they typically realize a below-single-digit growth rate each year. Then we have a regulatory-driven mix impact every 10 years or so, and we smooth that out over time. If I add volume and price together, that gives us a 5% organic growth rate. There are other growth drivers that we've seen over the years. M&A is a key one, and it's opportunistic. If we smooth that out, we expect that to add another 2% to growth. [00:00:00] S0: I know it could be hard to model any future M&A or take any forecasting or view on that. How much does that play a role? Whether it's new joint ventures, acquiring more distributors, is that a key piece of the DNA? And maybe it was in the beginning, and it is now. But how would you describe that in terms of playing a role?
· Alan Murran
[00:00:00] S1: It is an important driver of returns through the cycle. It's worth understanding what types of companies that Watsco does buy. These are family-run distributors and they can be up to third generation. As a consequence, deals can take years to come to fruition and often require some sort of catalyst within the family. In the meantime, Watsco's pitch to these companies is compelling. They say, come and join our Watsco family. That's not just talk. It's backed by a decentralized philosophy with the companies retaining their brands and their teams. Then they benefit from Watsco's expertise, their capital, and their technology. Broadly, there are three components to Watsco's M&A philosophy. One is cultural alignment. The second one is about the fact that Watsco looks to acquire quality businesses. The third is around financial discipline. If you think about culture, this is all about the alignment between the selling family and Watsco. It's probably the most important thing for Watsco. The second is around the fact that Watsco looks to buy performing businesses and not turnarounds. Finally on financial discipline, they look to use minimal debt in their M&A. As the leadership of Watsco likes to say, they never bet the ranch. This philosophy ties back to the family ownership that wants a company to endure and succeed over the long run. When you look at 15-plus years of transcripts, you can see this philosophy consistently articulated by the entire management team. What's also interesting is the growth potential for a company underneath the Watsco umbrella. They did a deal with a distributor called Russell Sigler here. They bought a 35% stake in the business back in 2017. If you look at the accounts today, you can see this value of the stake as it's based on a fixed multiple of operating profit. Therefore you can calculate that the operating profit has grown over 400% since they did that deal. That's a great example of the potential benefit of these acquisitions to investors. This is due to both hard work at the subsidiary, and also Watsco's expertise, relationships, capital, and technology. These technology improvements have been and continue to be an additional catalyst for deals. Since 2017, they've done over nine deals, adding over $1.2 billion of revenue. They have the balance sheet in place and the appetite to do more deals.