No slowdown in sight as Watsco

eyes long-term future growth

BY MARY JO MARTIN
Editorial director

Just two decades ago, Watsco began its transition to solely a distribution business from its manufacturing roots -- and has realized tremendous success in the ensuing years. Publicly traded, Watsco’s revenues have grown from $65 million since entering distribution to $1.8 billion currently.

And with just around 8% market share, its executive leadership is confident that there is much more growth ahead.

Watsco’s strategy for growth is two-fold:

• Growth through acquisition of great businesses
• Continuous investment in its location network to provide customers with great service and a broad product offering.

“We have always been an acquisitive company,” said senior vice president Barry Logan. “Every market in the U.S. has a group of market-dominant distributors that have taken decades to establish themselves and develop relationships. These close customer relationships, at the end of the day, are what really matters. So acquisitions are a way for owners to maintain and grow these relationships, with our capital and vendor relationships that, quite frankly, no one else has.

“We always seek businesses that can benefit from additional investment to ensure continued success for their customers and employees. Sometimes families are not comfortable adding more debt or putting more capital at risk. Watsco, being a public company, has access to large amounts of capital and profitable growth in many respects is what is rewarded over the long haul.”

Founded in 1947 by William Wagner as a heating and cooling equipment and door and window parts manufacturer, Watsco became a publicly listed company in 1962, and joined the American Stock Exchange in 1968.

Chairman, president and ceo Al Nahmad has been with Watsco since 1973 when he acquired a controlling interest in the company. He has led the Watsco through three decades of significant growth, beginning with the acquisition of several small manufacturing companies, and then charting the new course of HVAC distribution with the $17-million purchase of Gemaire Dis­tributors Inc., a Florida Rheem distributor in 1989. In 1990, Watsco acquired the California Rheem distributor Heating & Cooling Supply Inc., and within five years, purchased two other Rheem distributors, one in Texas and another in North Carolina. Around that time, about three-quarters of its business came from hvac distribution-related sales, and Watsco moved from the American Stock Exchange to the New York Stock Exchange.
By 1997, Watsco added other oems to the mix including Carrier/icp, Nordyne, Goodman and American Standard, and moved into commercial refrigeration thanks to the acquisition of Baker Distributing. Watsco exited the manufacturing business in 1999.

The art of the deal

When looking into acquisitions, Watsco has several key criteria that it is most interested in:

• The larger the better (although they will evaluate any opportunity)
• Demonstrated long-term success of growth and earnings (Watsco does not fashion itself as a turn-around expert)
• A committed team in place (they don’t want to make drastic changes with acquired companies; rather to support them and help them function even more effectively going forward).

“Each distributor’s approach to market and way it interacts with its customers is unique,” Logan noted. “The relationship that is built over many years at the counter is what makes each company different and successful. We do everything possible not to disrupt this relationship at the customer level by honoring the historical nature of each business acquired. However, based on what they tell us, we will support a newly acquired company with additional products and resources to better serve their customers.

“It is also key for us to foster an entrepreneurial spirit after an acquisition. We work very hard to motivate and compensate employees to continue their success in growing profitable businesses.”

Recognizing just how crucial those companies’ historical roots are with customers, it is Watsco’s desire that in most cases its subsidiaries retain their original names.

“We don’t want anything to change from the customers’ perception or viewpoint after an acquisition occurs,” Logan explained. “It is what is familiar to them -- not to mention that reputations have taken decades to develop. Our goal, and our obligation to the organization, is not to disrupt this relationship in any way.”

Watsco’s hope is that when they acquire a company, the only difference a customer sees is additional products, more locations, and more training and resources available to them. They be­lieve contractors continue to shop at these locations and not their competitors because of the tradition and strengths each wholesaler built over the years, which is why they want to sustain the historical culture.

There are a number of cases where Watsco has multiple branches in a single market operating under different names. These branches also have different legacies, products and strengths. The organization works very hard to ensure that each branch maintains its autonomy within the Watsco family of companies.

It’s evident when looking at Watsco’s structure that the subsidiaries maintain a great deal of autonomy when it comes to day-to-day decision making. In fact, Watsco’s corporate office has only 16 people -- out of a total of 3,500 employees! It all goes back to Watsco’s commitment to honor the relationships that have been established over the years in local markets.

“Watsco operates on a decentralized basis so management teams are close to their customers and are empowered to make marketing and operational decisions tailored to their particular customer base,” explained Logan. “As a result of this strategy, Watsco has also been able to retain top talent as the presidents of Watsco’s subsidiaries have an average of over 25 years of experience in the industry.”

Purchasing power
Of course, a major advantage that Watsco’s subsidiaries have is the vast purchasing power that the overall organization can leverage with its vendors. However, all purchasing is still done at the company level -- and each company maintains its own relationship with their respective vendors.

“We work with our companies to find ways to improve relationships with our vendors that might not be easily identified given our decentralized structure,” Logan noted. “Many times our subsidiaries identify products and relationships that they would like to offer their customers but they would have a hard time starting those relationships or getting those products independently. It is our role at the Watsco level to work with our family of companies to build these vendor relationships to make sure each company is operating and serving its customers at its highest potential.”

Approximately 90% of Watsco’s total sales are related to the residential hvac market. Its commercial refrigeration business makes up the remaining 10% and is part of the Baker Distributing subsidiary. Overall, Watsco estimates that sales related to add-on/replacement activities (ie, not new construction) are about 80% of its total sales.

The U.S. Sunbelt is responsible for about 90% of the organization’s total sales. Logan believes the reasons for that are because:

• Air conditioning is an absolute necessity
• There has been population migration/growth
• Units are replaced more often from wear and tear
• There are more dependable weather patterns
• It’s where the big markets are (Texas, Florida and California represent over 30% of U.S. hvac shipments).

“This has proven to be a vital and consistent source of long-term growth and earnings for us,” he explained. “Our view is that the stability and importance of the replacement market should grow over time given the Sunbelt’s necessity for hvacr products as the installed base of over 100 million central air conditioning and heating systems will eventually be replaced with product solutions that offer substantially higher energy efficiency and lower costs to the homeowner.”

One way that Watsco is attempting to boost sales and consumer interest is through a new website they developed, www.ACDoctor.com. This e-commerce tool is designed to help consumers make more informed decisions when it comes to their hvac systems.

“Consumers looking to purchase or replace hvac systems many times do not know what options are available to them and what the implications are for choosing certain systems,” Logan explained. “Traditionally, it has been the contractor educating and directing consumers on hvac-related decisions. Many consumers feel unable to make educated decisions during this process, which drove Watsco to develop ACDoctor.com.”

When visiting the website, users will find:

• Energy saving calculators
• Tips on keeping energy bills low, energy efficiency high and improving the quality of indoor air for everyday consumers
• Tools/data to compare HVAC systems
• Locators to connect with high quality contractors
• How to cash in on financial incentives to make purchases easier and more affordable.

Riding the economic roller coaster
Overall, Watsco’s same-store sales declined around 10% so far in 2008 (while new construction was down 50%+ in many of its key markets). In March 2008, the organization developed a “Profit Assurance Initiative” -- a program that allowed its subsidiaries to plan for this declining sales environment and identify a number of ways to ensure continued profitability.

“First, and most important, these initiatives were developed at the subsidiary level and not at Watsco,” Logan noted. “Each business is managed differently and each one identified different areas to improve efficiency and maintain or improve profitability. The advantage of Watsco, again, was that these different businesses were able to openly brainstorm, share countless ideas and plans of action which benefited each Watsco subsidiary.

“Key to all of this is that while we are responding to market dynamics we have maintained an intense focus to provide great service to our customers with an emphasis on promoting higher-efficiency products.”

With the economic -- and specifically construction -- slow down the U.S. has been experiencing, the subsidiaries have seen the additional benefits of this information exchange.

“Given the current factors affecting our markets, namely a slowing in sales, it is key to identify places our subsidiaries are doing things well and areas needing improvement in order to further strengthen our operating efficiency across the entire family of companies,” Logan commented. “Again, it isn’t Watsco making these decisions or prescribing these solutions, it is the business leaders who are deeply involved in all aspects of day-to-day and strategic operations of the business.”

Advantageous position
While the vast majority of distributors in this industry are privately held, Watsco has been publicly traded for nearly its entire existence. According to Logan, this public status gives Watsco a number of advantages that boosts their position in the market place:

• Access to capital to invest in existing network and acquire new businesses.
• Outstanding vendor relationships. Being publicly traded with stated goals and objectives, dedicated shareholders, ability to invest in additional branches and products, and regulated financials gives vendors confidence in Watsco as a true and long-term partner.
• Systems in place. Given the Sarbanes Oxley rules and Watsco’s size, the organization operates with the highest ethical standards and is able to pass those that onto its customers.
• Employee ownership. Watsco’s employees are able to directly participate in its performance by owning stock in their 401K programs (via company match) and a variety of other stock ownership programs available to employees. This has proven to be a great retention and motivating factor for Watsco employees.

Of course, the slow-down of new construction and existing home sales has been a major influence on the market. However, Watsco executives are still pleased with the organization’s performance. There has been a slight slowing of growth in their refrigeration business, but in general it continued to grow throughout 2008.

“Many consumers in Northern climates are finding it difficult to write checks to pay for new air conditioning systems in their home,” explained Logan. “Given the fact that our focus is in the Sunbelt, many consumers don’t have the option to ‘repair’ their systems and still need to replace their systems since air conditioning is such a necessity and used throughout the year.

“We have facilitated relationships with ge Credit and our contractor customers are able to provide their customers with longer term payment plans to soften the upfront cost of replacing an air conditioning system.”

In recent years, Watsco has been named to some pretty exclusive lists, including the Fortune 1000, Forbes Platinum List of the 400 Best Big Companies In America and Forbes 100 Best Mid-Cap Stocks, among others. Such recognition is taken in stride by those at the company’s headquarters.

“It is always great to get recognition in the market for growth and profitability, but it is really only a consequence of sticking to the same principles over long period of time,” said Logan. “Our focus has always been long term and we will maintain a disciplined approach of building a much larger company using the same conservative principles that have gotten us this far.

“Our 20-year record as a distributor shows revenues have grown at a compounded annual rate of over 20% and our market capitalization of has increased more than 60-fold to over $1 billion. However, our market share is just 8% of the estimated $26-billion market for hvacr products. We intend to grow our leading market position substantially in the coming years. We are confident we will be able to achieve this growth in market share as we’ve already achieved double-digit market share in certain very competitive markets.

“In addition to growth, we are also proud of our track record for sending cash to shareholders through increasing dividends. We’ve paid dividends for over 30 years and since 2000, our dividend has grown at a compounded annual rate of over 40%. 2008 marks the seventh consecutive year of a dividend increase, a strong signal of our commitment and confidence in our ability to generate strong cash flow.” n

To learn more, visit www.watsco.com.