New Housing Holds Back Watsco

Watsco Inc. (WSO - Analyst Report) has the liquidity position and the de-levered balance sheet to continue with its aggressive acquisition strategy. With high energy prices likely to persist over the near future, we believe consumers will increase the purchase of higher-efficiency air conditioning systems.

We also feel the strength of the replacement market can offset some of the rapid deterioration in the new home market in 2008. We recommend investors Hold WSO shares in their portfolio. Our target price is $41.50, or 17.4x our 2008 EPS estimate of $2.38.

Despite its attractive long-term story, WSO shares are likely to under-perform the market on account of its sales exposure to the new housing market. While the company should be able to offset some of the deceleration in the new home activity with replacement demand, we would not consider adding shares to our portfolio at the current price until the signs of a true bottom in residential construction activity appear. We do not anticipate this to happen until 2009.

We have valued Watsco using the P/E valuation metrics and forward earnings estimates. At its current price, WSO trades at a P/E of approximately 17.2x our 2008 EPS estimate of $2.38. This is at a premium to the industry median multiple. Given Watsco's industry-leading position, clean balance sheet, and ability to gain scale through acquisitions, we believe the P/E multiple assigned to WSO should expand relative to its peers.

Read the full analyst report on WSO