Watsco – SWOT Analysis

Watsco is one of the largest independent distributors of HVAC products in the US.Through its large distributor network and superior market position the company enhances its brand image and is in a favorable position to effectively meet competitive pressures. However, increasing raw material prices could affect the company’s operating margins.

Strengths

Weaknesses

Strong market position Innovations Strategic acquisition

Overdependence on the US market Weak financial performance

Opportunities

Threats

Growing replacement market Growth in US HVAC market

Increasing raw material prices Growing competition from Asia Slow down of US economy

Strengths

Strong Market Position
Watsco is one of the largest independent distributors of HVAC products in the US. The company has approximately 1,300 distributors in the US. Watsco serves over 40,000 contractor customers from 434 locations in 34 states in the US and Puerto Rico. Its products consist of a wide variety of air conditioning, heating and refrigeration equipment, parts and supplies used in residential, light commercial and industrial applications.The company carries approximately 50,000 SKUs of HVAC/R equipment, parts and supplies for residential and light commercial applications. Strong market position enhances its brand image and enables the company to attract large customers. In addition, Strong market position increases the bargaining power of the company.

Innovations
Technology used in the HVAC distribution industry has typically focused on simple inventory management and customer billing applications. Watsco has implemented new technologies to add greater value and ultimately revolutionize the distribution channel. Key innovations by Watsco include the development of ACDoctor.com, the introduction of eCommerce capabilities on each subsidiary website and a business model that promotes a harmony of independent subsidiary operations with cost-saving muscle of the largest HVAC distributor.
ACDoctor.com is a unique service that matches a consumer’s request for HVAC service with a qualified contractor. The service assists consumers in making informed HVAC decisions, while helping Watsco’s contractor customers acquire more business. The early implementation of eCommerce capabilities on all of its subsidiary websites has made Watsco one of the leaders in the online business environment. Watsco’s experience in delivering eCommerce services results in better service to the growing number of contractor customers conducting business over the Internet. Watsco’s most important innovation is the ability to leverage the purchasing power of the largest independent HVAC distributor, while continuing with local accountability for each subsidiary. New technology brings opportunities for improved execution at the point-of-sale, improved selling margins, greater merchandising capabilities, advanced service to customers and opportunities for reductions in working capital. These new innovations help the company to attain competitive edge over its peers.

Strategic Acquisition
Watsco focuses on inorganic growth for growth in its earnings. In 2007, Watsco acquired ACR Group, which is one of the nation’s largest distributors of air conditioning and heating products. ACR is based in Houston, Texas and operates from 54 locations serving over 12,000 air conditioning and heating contractors throughout Florida, Texas, California, Georgia, Tennessee, Arizona, Colorado, Louisiana, Nevada and New Mexico. The ACR transaction added over $200 million of annualized revenues and 54 new locations supplementing the company’s market coverage in key Sunbelt states and adding six locations in two new states to Watsco’s national footprint. This acquisition helps Watsco to increase its profitability, operational flexibility and productivity.

Weaknesses

Overdependence on the US Market
Watsco depends heavily on the US market for its revenues. The company derives almost all of its revenues from its domestic market. Considering the sluggish nature of the US market, there is a need for Watsco to widen the horizons of its operations beyond the US as any downturn in the US economy could have an adverse effect on the company’s operations and revenues. Also, with very little or no presence in emerging countries like India and China, where the demand for HVAC products and services is increasing, Watsco is loosing immense opportunity.

Weak Financial Performance
The company has recorded weak financial performance in 2007.Watsco’s revenue decreased from $1,771.2 million in 2006 to $1,758 million in 2007, a decrease of 0.7% compared with 2006. The decrease in revenues was due to a decline of 5% in sales of HVAC equipment and an 11% decline in the sale of other HVAC products.The decrease in sales was primarily related to a decline in sales of the new construction market.
Watsco also witnessed significant decrease in its net and operating profits for the same time period. The net profit decreased from $82.4 million in 2006 to $65.6 million in 2007. The operating profit of the company decreased from $135.4 million in 2006 to $111.2 million in 2007. Weak financial performance does not provide financial stability to the company and limits its growth avenues in the future. It can also negatively affect investor confidence

Opportunities

Growing Replacement Market
The company expects a big boom in the replacement market for air conditioners as new environmental regulations come into effect. For instance, many of its air conditioning systems utilize hydrochlorofluorocarbons (HCFCs) as refrigerants. The 1990 Clean Air Act amendments and the Montreal Protocol will require the phase-out of the production of these refrigerants. The use of all HCFCs in new equipment within the US must be phased out by 2010. The phase-in of substitute refrigerants, in turn, would necessitate replacement or modification of much of the air conditioning equipment already installed. Similarly, new regulations would require more anti-leak and anti-scaling products for homes and commercial purposes. About 70% of Watsco’s sales are to the replacement market. This would provide the company a significant market opportunity.

Growth in US HVAC Market
The US HVAC market has witnessed strong growth in recent past. Demand in the US for heating, ventilation and air conditioning (HVAC) equipment is forecast to increase 3.2 percent per year to $16.8 billion in 2011. Strong gains in nonresidential construction, along with ongoing growth in the residential replacement market drive the HVAC market. Growth in the replacement sector will benefit from rising interest in more energy efficient building systems driven by rising energy prices, spurring the replacement of older HVAC equipment with newer models. Changing regulations regarding minimum efficiency requirements for many of these systems will also affect sales of HVAC equipment. The company provides a wide range of HVAC products. Hence the company is well positioned to capitalize on the growing HVAC market.

Threats

Increasing Raw Material Prices
Steel, copper and aluminum account for the bulk of the company’s raw material purchases. The price of steel, a key raw material used for the manufacturing of HVAC products has increased in recent years. The price of cold rolled steel coil rose from $530 per ton in March 2007 to a high of $805 per ton in March 2008.The ongoing industry consolidation in the steel industry, which recently saw Mittal Steel taking over Arcelor to become the world largest steel conglomerate and Tata Steel taking over Corus to become the fifth largest steel conglomerate may create some monopoly in the market and lead to further increase in the prices.
Similarly, the price of copper increased from $6,452 per ton in March 2007 to $8,439 per ton in March 2008. Also, global prices of aluminum increased due to the rise in demand from China and Taiwan. The price of aluminum increased from $2,382 per ton in December 2007 to $2,777 per ton in February 2008. Continuing increase in the prices of raw materials, particularly, steel could have an adverse effect on the company’s operating results. Steel is one of the major raw materials for the HVAC industry and a continuous rise in prices could impact the margins of the company.

Growing Competition from Asia
The emergence of production facilities in Asia, especially China, where labor and manufacturing costs are extremely low, is posing a major threat to market participants in the US. Once local demand is met, Asian manufacturers look toward the US markets to maintain their pace of growth, thereby affecting the prospects of the native US companies. Unlike the US companies, Asian manufacturers have the additional advantage of a flexible legal framework, limiting the scope for litigation and thereby, eliminating various business restrictions, obstacles, and costs.
Recent global expansion by South Korea and China based air-conditioning manufacturers, particularly in the market for small residential units, has also resulted in intensification of price competition. The price competition in the market is mainly centered on residential air conditioning as retail customers are more price sensitive than commercial customers. Increased price competition puts pressure on the company’s margins and impedes growth in its market share.

Slow Down of US Economy
According to the IMF world economy outlook, the real GDP growth of the US and is expected to slowdown in 2008. The GDP growth of the US economy is forecasted to slow down from 3.3% in 2006 to 2.8% in 2008. The US, Watsco’s largest geographical market, accounts for the majority of the total revenues in the fiscal year 2007. Therefore, a weak economic outlook for US may put pressure on the revenues of the company.

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