On Tuesday, a settlement agreement was filed in the regional efficiency standards lawsuit. Essentially, HVAC distributors in the South and Southwest will have 18 months (July 1, 2016) to sell any inventory of 13-SEER equipment that was manufactured before January 1, 2015. The Department of Energy (DOE) had first mandated that as of January 1, 2015, all replacement and new construction HVAC equipment installed in the South had to be SEER 14 or higher. Under the original rule, Watsco would have enjoyed 2%-3% of price/mix in 2015.
About 30% of sales are split-systems and roughly 70% of sales are in the South. SEER 14 units are priced 10%-15% higher than comparable SEER 13 units. We knew there was a chance the HARDI lawsuit might push the timing of this transition back, so we did not bake the price/mix upside into our model. Instead of price/mix boosting 2015, the lift should now come in 2016. There is no change to our forecast or Outperform rating. Key reasons to continue owning shares include further broadening of the HVAC replacement cycle; possible upside to housing starts, new technology initiatives that could drive sales, pricing, and productivity; the potential for rising R-22 prices to force the transition to R410A equipment; and a rising dividend.
The energy-efficiency standard for residential gas furnaces in the northern region has been remanded. The DOE will begin assessing a new standard and has agreed to use a more transparent process. It is likely that a new furnace standard would not take effect until 2021-2022. On January 1, 2015, the efficiency standard for central air conditioners in the South will be 14-SEER. In the Southwest, that standard will be 14-SEER/12 EER.
Distributors in the South and Southwest will have 18 months (July 1, 2016) to sell any inventory of 13-SEER equipment that was manufactured before January 1, 2015. The DOE has agreed to not assess civil penalty upon distributors for violations related to the enforcement of regional efficiency standards for central air conditioners and heat pumps.
At about $100, the stock is trading at 23 times 2014 EPS estimate, which compares with a five-year average of 21 times. We believe the multiple reflects improved sentiment toward residential housing and the potential for continued 20% EPS growth as pent-up demand releases, growth initiatives kick in, and the last Sunbelt Carrier option is exercised.
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