Watsco

Company overview

Watsco is the largest distributor of residential and light-commercial heating, ventilation, air-conditioning and refrigeration (HVAC/R) equipment, parts and supplies in the Americas, with 723 locations at 30 June 2026. FY25 revenue was $7.24bn: HVAC equipment 67%, other HVAC products 29% and commercial refrigeration 4%. Its customers are contractors and dealers who replace and install systems, so replacement of the installed base, not new construction, drives most demand. Much of the business runs through consolidated joint ventures with Carrier, which owns 20% (40% in Canada), and Watsco has two share classes, Common and ten-vote Class B.

A long-only client that has owned the stock for a decade wants a fresh, independent view after its worst year in a long time. Gross margin was 28.0% in FY25, helped by the pass-through of large 2025 OEM price increases during the transition to A2L refrigerant systems. In 2Q26 it fell to 27.5% (−180 bp year on year); operating income fell 12.3% and diluted EPS of $4.00 missed a published consensus range of $4.38–$4.51. The shares fell about 13% on 29 July 2026 and closed at $279.90 on 9 October, down from a 52-week high of $459.00.

Volumes have stopped falling: same-store sales fell 5% in FY25, were flat in 1H26 and rose 1% in 2Q26. Watsco bought Jackson Supply on 1 June 2026 for 517,884 shares worth $186.2M and on 12 September 2026 agreed to buy Granite Group for $505.0M, subject to antitrust clearance. The Federal Reserve raised its target range to 3.75–4.00% on 16 September 2026 and the 10-year Treasury closed at 5.24% on 9 October. Watsco pays out roughly all of its earnings as dividends (annual rate $13.20 since April 2026), so it trades partly as a yield stock. The balance sheet holds net cash: $364.2M of cash and $100.0M of Treasury bills at 30 June 2026, with the revolver undrawn.

You are an Associate in the Industrials & Distribution group of an investment bank. The Managing Director wants a written view, and a model they can defend in front of the client: at $279.90, is Watsco now cheap, or has the market simply re-based an over-earning business? Your memo is what gets graded here. The assignment also asks for an integrated FY26E–FY30E model in the student template, which you can attach as a supporting file. The case uses public information only and is a training exercise, not investment advice.

Your client memo should answer

1. 01Recommendation and price target. Rating (Outperform / Neutral / Underperform), 12-month price target and expected total return including dividends, in the first three sentences.
2. 02Investment thesis. Three numbered points, each tied to a number in your model.
3. 03Normalised earnings. What is a "normal" gross margin for Watsco after the 2025 OEM price pass-through, and what does that imply for FY26E–FY27E EPS?
4. 04Who owns what. Explain the Carrier joint ventures, how Carrier's minority interest should be valued in your equity bridge, and the two share classes. State the share count you divide by and why.
5. 05What the market is pricing in. Back out the exit multiple or perpetual growth rate implied by $279.90.
6. 06Valuation. DCF (both terminal methods) and trading comparables, summarised in a football field. Explain why the methods differ.
7. 07Capital allocation and risks. Dividend coverage, the Granite acquisition (quantify its effect under stated assumptions), housing and replacement demand, OEM pricing. At least one quantified downside case.
8. 08Catalysts. What you would watch at 3Q26 results and in the 2027 outlook.

Financials ($M)

Term sheet

Mandate

Independent view on Watsco (WSO) for a long-only client: rating, 12-month price target and expected total return including dividends

Company

Watsco, Inc. (NYSE: WSO; Common and Class B shares) · Miami, Florida · calendar fiscal year

Case date

Friday 9 October 2026 (market data as of the close). Latest filing: 10-Q for the six months to 30 June 2026.

Your role

Associate in the Industrials & Distribution group of an investment bank, writing for a long-only client that has owned Watsco for a decade

Share price

$279.90 at the close on 9 Oct 2026; 52-week high $459.00, low $277.34

Shares

35,588,756 Common and 5,663,438 Class B shares outstanding at 4 August 2026, including unvested restricted stock

Net cash

$364.2M of cash and $100.0M of Treasury bills at 30 June 2026; the $600M revolver ($500M from October to March) was undrawn

Dividend

Annual rate $13.20 per share since April 2026; $3.30 paid on 31 July 2026, deducted when you roll value forward to 9 October 2026

Assignment 1: memo

Written memo the Managing Director can send to the client, no more than three pages plus up to two pages of exhibits

Assignment 2: model

Five-year (FY26E–FY30E) integrated model in the template: revenue build (same-store plus acquired), working capital on days, three statements with two-class EPS and Carrier NCI, seasonal revolver, DCF, comps, three sensitivity grids, football field and a one-page Granite scenario

Periods

Calendar years; LTM Jun-26 = FY25A + 6M26A − 6M25A as a formula

Tax

The consolidated effective tax rate (~20–21% of pre-tax income) is lower than the ~23% reported on income attributable to Watsco. Explain why and use the consolidated rate consistently

Shares convention

Two-class EPS uses weighted shares excluding unvested restricted stock and deducts earnings allocated to it. Value per share must use all shares outstanding (Common + Class B, including restricted). Do not mix the two

Valuation date

Discount to 30 June 2026 and roll the equity value forward to 9 October 2026; deduct the $3.30 dividend paid on 31 July 2026

Market inputs

Use the price, share count, Treasury yield and peer data in the template. A different equity risk premium, beta or terminal assumption needs a dated source or a Judgment label with a rationale

Market data and valuation inputs (close of 9 Oct 2026 unless stated; from the student template's Inputs tab)

WSO share price (close)

$279.90

52-week high / low

$459.00 / $277.34

Shares outstanding, Common + Class B incl. restricted (10-Q 2Q26 cover, 4 Aug 2026)

41.252194M (35,588,756 Common + 5,663,438 Class B)

Dilutive securities (options, treasury method)

0.031081M

Weighted diluted shares used for EPS (6M26)

38.079266M (excludes unvested restricted stock)

Cash + short-term investments (30 Jun 2026)

$464.2M (cash $364.2M + Treasury bills $100.0M)

Debt: finance leases (30 Jun 2026)

$13.961M; revolver ($600M, $500M from October to March) undrawn; operating leases excluded

Carrier's non-controlling interest (book, 30 Jun 2026)

$478.8M; the template asks you to value Carrier's share at market, not book

Dividend paid between 30 Jun and 9 Oct 2026

$3.30 per share, paid 31 Jul 2026

Risk-free rate: 10-year US Treasury (CMT, 9 Oct 2026)

5.24%

Equity risk premium

4.20% (Damodaran implied ERP, 1 Oct 2026)

Pre-tax cost of debt

5.00% (base rate 3.90% + 1.10% revolver margin)

Marginal tax rate (for unlevering beta)

25% (Judgment: 21% federal + ~4% state)

WSO beta, 2-year weekly vs S&P 500

0.897 raw / 0.931 Blume-adjusted

Fed funds target range

3.75%–4.00% (FOMC, 16 Sep 2026)

Terminal growth rate and exit multiple

Your judgment: blank in the template; give a dated source or label it Judgment

Trading comparables: inputs ($M except per share; LTM = FY + YTD − prior-year YTD (Ferguson's LTM is annualised from 11 months after its fiscal-year change); equity value, EV and multiples are yours to build)

FERG · Ferguson Enterprises (LTM to 30 Jun 2026)

Price $220.04; diluted shares 193.453M; debt incl. finance leases $4,904.0M; cash $437.0M; LTM revenue $31,697.5M; LTM EBITDA $3,225.8M; LTM net income $2,035.6M; LTM diluted EPS $10.44; beta 0.982 raw / 0.988 adjusted

POOL · Pool Corporation (LTM to 30 Jun 2026)

Price $159.54; diluted shares 36.341M; debt incl. finance leases $1,340.7M; cash $28.8M; LTM revenue $5,394.3M; LTM EBITDA $634.0M; LTM net income $399.9M; LTM diluted EPS $10.89; beta 0.664 raw / 0.775 adjusted

SITE · SiteOne Landscape Supply (LTM to 28 Jun 2026)

Price $87.16; diluted shares 43.655M; debt incl. finance leases $643.0M; cash $87.4M; LTM revenue $4,774.6M; LTM EBITDA $388.8M; LTM net income $162.8M; LTM diluted EPS $3.65; beta 1.075 raw / 1.050 adjusted

CNM · Core & Main (LTM to 2 Aug 2026)

Price $40.35; diluted shares 190.494M; debt incl. finance leases $2,449.0M; cash $312.0M; LTM revenue $7,698.0M; LTM EBITDA $935.0M; LTM net income $459.0M; LTM diluted EPS $2.43; beta 0.911 raw / 0.940 adjusted

GWW · W.W. Grainger (LTM to 30 Jun 2026)

Price $1,289.79; diluted shares 47.101M; debt incl. finance leases $2,408.0M; cash $589.0M; other claims (NCI) $382.0M; LTM revenue $18,845.0M; LTM EBITDA $3,077.0M; LTM net income $1,870.0M; LTM diluted EPS $39.23; beta 0.681 raw / 0.786 adjusted

Operating and working-capital data (FY22A / FY23A / FY24A / FY25A, year-end balances unless stated)

Same-store sales growth

FY25 -5.0%; 6M26 0.0% (2Q26 +1%)

Locations, period end

FY25 695; Jun-26 723

Revenue mix, FY25

HVAC equipment 67%, other HVAC products 29%, commercial refrigeration 4%

DSO (days)

37.5 / 40.0 / 42.1 / 40.1 (Jun-26: 53.2)

DIO (days)

95.4 / 92.9 / 90.7 / 97.1 (Jun-26: 130.7)

DPO (days)

31.7 / 25.5 / 32.1 / 24.6 (Jun-26: 45.6)

Cash conversion cycle (days)

101.1 / 107.4 / 100.6 / 112.7 (Jun-26: 138.2)

Seasonality

June inventory is 41.0% (2025) and 36.4% (2026) above the prior December, built for the cooling season; 1H operating cash flow is usually negative

Payouts vs free cash flow

FY25 dividends paid $473.8M (95% of net income attributable to Watsco) plus $131.2M of distributions to Carrier, against FY25 operating cash flow of $569.6M; $281.8M of new shares sold at the market in FY24

Ownership, share classes and acquisitions (10-K FY25, 10-Q 2Q26 and 8-K filings)

Carrier joint ventures

Carrier Enterprise I, Carrier Enterprise II and Totaline Enterprise (Watsco 80% / Carrier 20%); Carrier Enterprise III in Canada (60% / 40%). Consolidated, with Carrier's share shown as a non-controlling interest

Russell Sigler (RSI)

Carrier Enterprise I owns 38.4% (equity method); Watsco's share of RSI net income ($27.8M in FY25) is reported inside operating income

Two share classes

Common (one vote) and Class B (ten votes; elects 75% of the board; converts 1:1; cannot receive a lower dividend than Common)

Tax

Consolidated effective rate ~20–21% of pre-tax income vs the ~23% reported on income attributable to Watsco

Jackson Supply (closed 1 Jun 2026)

25 branches, about $230M of annual sales; paid in 517,884 shares worth $186.2M

Granite Group (agreed 12 Sep 2026, pending antitrust clearance)

Northeast plumbing and HVAC distributor, about $500M of sales; $505.0M (80% cash, 20% stock). Exclude from the base case; model as a scenario

Dividend

Annual rate $13.20 per share since April 2026