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Watsco Inc. (WSO - Analyst Report) is set to report third quarter fiscal 2013 results before the opening bell on Oct 16. Watsco’s earnings per share and revenues were both at an all-time high in the second quarter of 2013. Last quarter it posted a 4.96% positive surprise. Let us see how things are shaping up prior to the announcement.

Factors to Consider This Quarter

Watsco will benefit from the demand in the replacement market as old units would get replaced by more energy-efficient units in the coming years. There are approximately 90 million central air conditioning and heating systems installed in the United States that have been in service for more than 10 years. Moreover, higher efficiency units drive higher pricing and higher margins for the company. Watsco’s joint venture with Carrier Corporation, a wholly-owned subsidiary of United Technologies Corp. (UTX - Analyst Report), remains successful and continues to generate profits. Watsco expects to meet or exceed its annual target of generating higher operating cash flow than net income in 2013.

However, in June, housing starts unexpectedly fell to the lowest level in almost a year to 836,000 units. Housing starts recovered somewhat to 8,83,000 units in July and 8,91000 in August. Though this is above the Jun 2013 figure, it was below expectations and also below the peak of just over 1 million in Mar 2013. Recent rise in mortgage rates in anticipation of the Federal Reserve tapering its massive bond purchase has made builders cautious about breaking ground on new projects. This puts a question on the expected recovery in the housing sector, which would have benefited Watsco.

Earnings Whispers?

Our proven model does not conclusively show that Watsco is likely to beat earnings this quarter. That is because a stock needs to have both a positive Earnings ESP (expected surprise prediction) and a Zacks Rank of #1, 2 or 3 for this to happen. That is not the case here as you will see below.

Negative Zacks ESP:  This is because the Most Accurate estimate stands at $1.41 while the Zacks Consensus Estimate is higher at $1.43. This comes to a difference of -1.40%.

Zacks Rank #3 (Hold): Watsco’s Zacks Rank #3 (Hold) lowers the predictive power of ESP because the Zacks Rank #3 when combined with a negative ESP, makes surprise prediction difficult.

We caution against stocks with Zacks Rank #4 and #5 (Sell rated stocks) going into the earnings announcement, especially when the company is seeing negative estimate revisions momentum.

Other Stocks to Consider

Here are some other companies in the peer group that can be considered, as our model shows they have the right combination of elements to post an earnings beat this quarter:

Arrow Electronics, Inc. (ARW - Analyst Report), Earnings ESP of +1.67% and a Zacks Rank #2 (Buy).

USG Corporation (USG - Snapshot Report), Earnings ESP of +3.57% and a Zacks Rank #3 (Hold).

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