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Watsco Inc. (WSO - Analyst Report) reported third-quarter 2013 adjusted earnings of $1.32 per share, up 11% from $1.19 per share earned in the year-ago quarter. The growth was aided by higher sales, stronger selling margins and continued operating cost management. However, the results missed the Zacks Consensus Estimate of $1.43.

Total revenue increased 6% year over year to a record $1.1 billion and was in line with the Zacks Consensus Estimate. Residential air conditioning and heating (HVAC) equipment increased 8%. Other HVAC products were up 3% and commercial refrigeration products grew 1%.

Cost and Margins

Cost of sales increased 5.8% year over year to $823.3 million. Gross profit grew 6.6% year over year to a record $258.6 million. Gross profit margin increased 10 basis points (bps) to 23.9% from 23.8% in the year-ago quarter. Selling, general and administrative expenses crept up 4% year over year to $163 million. Income from operations increased 11.4% year over year to a record $95.5 million. Operating margin increased 40 bps to 8.8%.

Financial Operations

Cash and cash equivalents were $29 million as of Sep 30, 2013, compared with $73.8 million as of Dec 31, 2012. Cash flow from operating activities for the period of nine months ended Sep 30, 2013 was $51 million, down from $64 million in the year ago comparable period. Debt-to-capitalization ratio was 20% as of Sep 30, 2013, compared with 24% as of Dec 31, 2012.

Watsco paid $26 million in dividends during the first nine months of 2013. On Oct 2, 2013, Watsco raised its quarterly dividend rate by 60% to 40 cents per share payable on Oct 31 to shareholders of record as of Oct 15.

Guidance for 2013

Watsco revised its earnings per share guidance to $3.65–$3.70 from $3.60–$3.75. This implies an annual growth rate of 20% to 22% over 2012.

Watsco expects strong residential HVAC systems sales in the U.S., which grew double digits, and an improved sales trend for commercial products. Watsco’s strong cash flow and healthy balance sheet will aid business growth.

Our Take

Watsco continues to increase its presence in the international markets. On the domestic front, the company continues to witness growth in the residential product segment and the momentum is expected to continue in the balance of 2013, aided by the recovery in the housing market.
 
Watsco has immense potential in the replacement market of air conditioners and heating systems in the U.S. Furthermore, increased investment opportunities, a solid balance sheet and favorable general economic conditions will drive growth.

Watsco currently retains a Zacks Rank #3 (Hold). Watsco’s peer Lennox International, Inc. (LII - Snapshot Report) is expected to report its third-quarter results on Oct 21, while Comfort Systems USA Inc. (FIX - Snapshot Report) will report on Oct 30 followed by Nortek Inc. (NTK) on Nov 4.

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