Volumes recover but pricing power fades for HVAC distributor
- Watsco operates 691 locations across the United States, Canada, Mexico, and Puerto Rico.
- Residential compressor-bearing system volumes grew 2 percent in the second quarter, signaling stabilization.
- Gross profit margins dropped 180 basis points as the company faced softer pricing power.
- The EPA removed the strict sell-through deadline for legacy 410A systems, clearing a major inventory hurdle.
- A recent acquisition of Jackson Supply Company adds 25 locations to the network.
Volume returns, margins retreat
Watsco benefits from massive scale in the fragmented HVAC distribution market. Contractors rely on the company to have the right equipment and parts locally available during critical heating and cooling seasons.
The second quarter of 2026 brought a significant shift. Demand stabilized with residential unit volumes growing 2 percent, reversing an 8 percent decline from the first quarter. Furthermore, the EPA definitively eliminated the 410A sell-through deadline, which removes a major regulatory overhang for legacy inventory.
However, the relief on volume came at a cost to profitability. Average selling price growth decelerated to 2 percent, down from 7 percent in the prior quarter. This loss of pricing power led to a 180 basis-point drop in gross margins.
The bull case points to a recovering volume trend and the removal of the 410A regulatory risk as signs that the worst of the demand slump is over. The bear case argues that without outsized price hikes to pass through, Watsco will struggle to maintain profit margins if unit growth stalls again.
Branches, brands, and contractor trust
Watsco makes money by moving heating, cooling, and refrigeration products from manufacturers to local contractors. Contractors need immediate access to parts and systems when units break, so local inventory availability is critical.
The business follows a seasonal pattern. Air conditioning demand peaks in the second and third quarters, while heating demand peaks in the first and fourth quarters. Extreme weather can drive surges in emergency replacements, while mild weather can soften sales.
Growth comes from organic branch expansion and acquiring smaller distributors. A recent example is the June 2026 purchase of Jackson Supply Company, which added 25 locations to the network.
The model is vulnerable when end consumers delay expensive system replacements or when supplier costs rise faster than Watsco can increase prices. Right now, the company is testing whether a slight return in volume can make up for shrinking profit margins.
What Watsco sells
HVAC equipment
This is the primary group, comprising 68 percent of recent sales. It includes residential systems, commercial systems, furnaces, and indoor components.
Other HVAC products
This category includes parts and supplies contractors need for repairs and installations, making up 28 percent of sales. Demand here is less volatile than full system replacements.
Commercial refrigeration products
A smaller product line at 4 percent of sales, providing exposure beyond residential heating and cooling.
Legacy 410A systems
These systems run on older refrigerants. The EPA recently eliminated the deadline to sell matching 410A systems, allowing Watsco to clear out legacy inventory without panic.
Q2 2026 sales mix
This mix is from the quarter ended June 30, 2026. Watsco reports major product lines rather than separate operating segments.
What could go wrong
Margin compression continues
High impact · High oddsGross margin fell 180 basis points in the second quarter of 2026 as pricing power faded. If Watsco cannot hold prices steady while supplier costs remain high, earnings will suffer.
Acquisition integration stumbles
Low impact · Low oddsThe company recently acquired Jackson Supply Company, adding 25 new locations. Integrating new branches requires aligning pricing technology, inventory systems, and culture.
Weather and housing weakness
Medium impact · Medium oddsWatsco relies on hot summers, cold winters, and housing activity to drive HVAC demand. Mild weather combined with soft home building can severely reduce contractor orders.
Tariffs raise product costs
Medium impact · Medium oddsMany HVAC suppliers source parts from China and assemble products in Mexico. Tariffs on these regions would raise supplier costs, forcing Watsco to hike prices and risk suppressing consumer demand.
Gree dispute disrupts supply
Low impact · Medium oddsWatsco and supplier Gree are disputing the renewal of a 10-year distribution agreement. While Gree products were less than 3 percent of trailing revenue, a supply cutoff could still hurt specific subsidiaries.
In one breath
What does Watsco do?
Watsco is a distributor of heating, ventilation, air conditioning, and refrigeration products. It sells equipment, parts, and supplies to contractors through a large branch network.
Are Watsco sales volumes growing?
Yes, residential unit volumes returned to growth in the second quarter of 2026, rising 2 percent after an 8 percent decline in the prior quarter.
What is the main bull case for Watsco?
The bull case is that unit volumes are recovering and the EPA removed a major regulatory deadline for legacy inventory. If volume growth holds, the worst of the demand slump may be over.
What is the main bear case for Watsco?
The bear case is that Watsco is losing its pricing power. Average selling price growth slowed significantly recently, causing a 180 basis-point drop in gross margins.
