Business Breakdowns
· Matt Reustle
[00:00:00] S0: There’s interesting similarities to another name that we covered with Heico in terms of having a business and then finding a related business that seemed much more fruitful and more advantageous, and then really leaning into that. Lucy, you tapped into the exclusivity dynamics, and this is something that's very interesting to me here. In certain industries, exclusivity can be very powerful. But it depends which side is getting the better side of that agreement. Exclusivity can be limiting in many ways. It can open up opportunities in many ways. Can you just walk through the exclusivity dynamics and how much that plays a role for Watsco?
· Lucy Adams
[00:00:00] S2: The first point to note is these exclusivity agreements are commonplace in the HVAC industry and, importantly, the deals are mutually exclusive. These are long-term strategic relationships. Both parties are working together to drive growth. If we go back to when I mentioned the service element that Watsco offers above distributing equipment and parts, these services not only help grow Watsco's business, but they're also beneficial for the manufacturers. This includes improving customer satisfaction and creating brand loyalty. That's things like customer support, aftermarket sales support such as warranties and training programs, and even providing e-commerce and technology platforms, which ultimately help the manufacturers capture online sales. What this does is that while Watsco can focus on delivering those services that help to grow both sides of the manufacturer's business, and Watsco's own sales, it in turn allows the manufacturers to focus solely on product innovation. The other important thing to understand about this industry dynamic is that it creates significant barriers to entry for new entrants. For example, it prevents others from entering either organically or through M&A, because it requires the specific approval of a manufacturer.
· Matt Reustle, Alan Murran
[00:00:00] S0: I have been picturing this through the residential lens throughout this conversation, but it is fair to bring up commercial, which you've mentioned several times. How much difference is there between commercial operations versus residential operations? Whether it's in the business model itself and the strategy around it, or more so in the numbers. [00:00:00] S1: Commercial and residential are quite similar. For example, they both have exclusivity agreements that Lucy just described between the manufacturer and the distributor. In addition, both parts of the business primarily relate to servicing replacement demand. Two differences to call out in Watsco's case would be that Watsco is less penetrated in the commercial space than in residential. Also, there's a slightly lower gross margin in the commercial space versus residential. [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.
· 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.