Watsco: Winning by digitizing an old industry
Watsco started in 1947 as Wagner Tool & Supply Corp. The company rebranded to Watsco in 1956 and went public in 1963. The company was a manufacturer of parts, components, and tools used in the HVAC/R industry. It was a decent business but nothing extraordinary.
In 1972 Albert H. Nahmad became chairman, president and CEO. He is still the CEO to this day and has his son Aaron, who joined Watsco in 2005 and led the technological transition of the company since 2016, to take over once he retires. The company continued to operate as usual until in 1989 they acquired an 80% interest in Gemaire in Florida and shifted their focus to distribution. Since then as a HVAC distribution pure play and active consolidator, Watsco grew from $22 million market in 1989 to over $19 billion today. Let’s discuss this extraordinary business and why it has an advantage over its peers.
The HVAC industry
According to GrandViewResearch, the US HVAC (Heating, Ventilation and Air Cooling) systems industry is expected to grow at 7.4% a year from $30.4 billion in 2023. The HVAC service market is expected to grow to $32.9 billion by 2030, although growing at a slower pace of 3%. Outside of the US, Watsco generates 5% of sales from Canada and 5% from LATAM/Caribbean.
Watsco works as an intermediary between the HVAC manufacturers and the contractors. Through their large network of offline stores and their online e-commerce platform, they offer over 1500 SKUs (the most extensive product catalog in the US). In the picture below you can see Watsco's Business model visualized. With over $7 billion in revenue, Watsco is almost twice as large as the closest competitor in the HVAC service space, giving them scale advantages.
HVAC is a fascinating industry with tailwinds and barriers to entry:
HVACs are often a necessity and not a luxury item, as seen in the map below.
Because of the necessity and the relatively infrequent purchasing frequency customers aren't price sensitive, so higher prices can easily be passed on to the customer. New HVACs are purchased on average every 10 years but need frequent servicing. Annual shipments of new systems in the US are around 10 million; the majority are replacement units. The aging install base in the US is over 115 million units that will need servicing and replacements.
HVACs need experts with technical expertise to install and service units and OEMs need to approve distributors, adding barriers to entry to the business model.
HVAC benefits from regulatory pressures to install increasingly efficient and environmentally friendly units. In 2023 the minimum SEER standard that a newly sold unit can have was increased, leading to new products being pushed with higher average prices. Distributors were allowed to sell existing inventories, but couldn't purchase new units under the minimum SEER level after 2023.
Aside from the beneficial secular tailwinds of the HVAC industry, Watsco has some unique competitive advantages that enabled it to rank #16 out of all listed companies over the last 30 years, based on its 20% total shareholder return CAGR.
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