Watsco Holds to 30% Gross Margin Target Despite Third-Quarter Decline to 26.4%
Key Facts
Watsco said its long-term gross margin target remains 30%, despite a margin of 26.4% in the third quarter of 2026, compared with 27.5% a year earlier. The chief executive said on the Oct. 27 results call that the company sees a path to the target, while acknowledging that the path will not be linear. The quarter saw revenue rise 7% to a record $2.22 billion, while gross profit increased 3% to a record $586 million. But earnings per share fell 5% to $3.77, reflecting a divergence between sales growth and pressure on margins and earnings. The results put the long-term 30% target above a lower quarterly margin, as the company describes the recovery in residential demand as ongoing.
Watsco attributed the margin decline to customer and end-market mix, as well as the timing and lower magnitude of manufacturer pricing moves in 2026 compared with 2025. It also cited differing growth rates for equipment sales and other products. By product, residential heating and air-conditioning equipment sales grew 7%, supported by a 5% increase in units and a 2% rise in average selling price. By contrast, commercial equipment sales fell 5% during the quarter. The company said same-store sales growth improved gradually through the selling season, and third-quarter results reflected a stable residential market after the prior year's transition to A2L products. It said the quarter's margin also came close to historical seasonality, while technology investments, pricing improvements and growth in non-equipment products support its long-term margin targets.
For the nine months ended Sept. 30, gross margin fell to 27.2% from 28.3% in the year-earlier period, and gross profit declined 1% to $1.59 billion. Operating cash flow, by contrast, rose 79% to $304 million over the same period. The results followed a second quarter in which the company posted a gross margin of 27.5%, compared with 29.3% a year earlier, while earnings per share fell 12% to $4. The comparison between the two quarters points to continued year-over-year margin pressure in 2026, despite improved residential sales in the third quarter. E-commerce sales totaled $2.75 billion in the 12 months ended Sept. 30, equivalent to 37% of revenue.
On expansion, Watsco completed its acquisition of The Granite Group in October, a distributor of heating, air-conditioning and plumbing products in the northeastern United States. It has annual sales of about $500 million and serves about 11,000 customers through 82 locations. The group offers about 29,000 products from more than 450 suppliers and has recorded compound annual sales growth of 10% since 2010. Deal disclosures had set total consideration at $505 million before post-closing adjustments, with 80% payable in cash and 20% in Watsco shares. The company said the Granite and Jackson acquisitions added 107 locations and $730 million in annual revenue to its network, and are expected to increase annual revenue by about 10% and expand its geographic reach and its product, customer and market mix.
On demand, Watsco said early fourth-quarter sales trends point to continued improvement in end-market demand, with residential units returning to growth and improving gradually through the selling season. The company did not confirm in these results that the regulatory transition to A2L products would be complete by the end of 2026; instead, it linked third-quarter performance to a stable market after the prior year's transition. Watsco shares closed at $305.33 on Oct. 26, before the results were announced the following day. After the announcement, the shares fell 4.22% in after-hours trading, as earnings missed analysts' expectations despite revenue topping their estimates. The market response thus reflected the earnings result, while management kept its focus on the path to margin recovery and its long-term target.