WDFC - WD-40 Company: The Market Is Never Wrong

2023-10-24 04:21:43 ET

Summary

• WD-40 Company's stock is viewed as a hold due to its slow and stable growth despite high valuations. The stock is perennially overpriced.
• Sales in the Americas are the bellwether.
• Margins improved with a gross margin of 51.4% in Q4, resulting from pricing increases and cost-cutting efforts.
• The view for 2024 EPS growth is anemic, so shares are very expensive.

We continue to own WD-40 Company ( WDFC ) stock. We view it as a hold. While shares are still and arguably have been perennially expensive, shares just never seem to really fall off the map and reset the valuation. It remains a very slow and stable grower over time, despite sporting valuations that are mid 30X FWD EPS. By most accounts this is a crazy multiple for a stock with slow revenue and EPS growth. There are many macro headwinds out there, and the pain of inflation has been notable for the company's input costs. The company has passed much of this on to customers. One thing we contend is that WD-40's products are pretty recession resistant. The products help keep older 'stuff' lasting longer and in better working order. In a recession people will be hesitant to replace what can be improved/repaired. We also contend that the operational performance of the company does not justify the premium on earnings you have to pay, but for years and years the market has disagreed. And the market is almost never wrong. So, who are we to question it? Thus, we are backing off of the call that it is "too expensive," however upside may be limited near-term, so we are continuing to hold. The forward view is for slow growth however. We believe the just reported earnings justify this call, and in this column we discuss the recent performance and forward view.

WDFC's topline growth continues

The company is continuing to regularly grow sales. In fiscal Q4 , on an absolute basis, sales for the fiscal third quarter were $140.5 million, up 7.7% from the $130.4 million last year. We were expecting sales of around $137.0 million, so this was actually an upside surprise. This also surpassed consensus by $2.3 million . We were looking for low single-digit increases in the top line. But the regional data is very interesting. We are seeing growth in all regions except Asia Pacific.

What we know from covering this stock for many years is that WD-40 Company has done a tremendous job working to grow the business internationally. We believe there remains many untapped regions of the world, particularly in emerging markets. Overall, net sales by location for fiscal Q4 were 53% in the Americas, 36% in EMEA, and 11% in the Asia-Pacific region.

Let's start with the Americas, where over half of the sales of this classic company's products are generated. Sales in the Americas increased 10%, driven by much higher sales of maintenance products in the United States , which increased a whopping 18%. However those sales were driven primarily by price increases, but there were increases in sales volume. In Canada , maintenance product sales actually decreased 3% due to lower levels of demand. We also noted that in Latin America , maintenance product sales decreased 12% stemming from decreases in the direct and distributor market sales. There was also a very strong comp to contend with a year ago. Over in Mexico maintenance products grew 19%. This was a result of continued adds of new points of distribution and added customers.

Turning to EMEA, sales rose a strong 16%, and this was a result of both price increases and promotions put into place by the company. Direct market sales increased 19% in the region. There were higher sales of maintenance products from those price increases but there was lower demand and decreased sales volume given the macro pressures. Net sales in the EMEA distributor markets also increased 9%.

In Asia-Pacific, net sales fell off 20% versus last year due to a major drop in sales of maintenance products in the Asian distributor markets, which declined 38%. Management indicated this was in large part due to the timing of customer orders. We can certainly believe this because in Q3, the sequential quarter, Asia-Pacific sales rose 42% from last year. What happens in the current fiscal Q1 will be telling however. Within this region we also have Australia where we saw sales about flat from last year, with lower sales volume of maintenance products but higher prices. Then in China, sales were down 4% percent thanks to lower customer orders.

So, the Americas continue to lead, and EMEA is strong, while Asia is lagging. One negative in the past has been margins. But we saw a nice margin increase.

Margins improved

We want to remind you that WD-40 Company has a long-term 55% gross margin target. For the past few quarters margins have been trending in the right direction. That said, gross margin in fiscal Q4 was 51.4% in Q4 versus 47.4% a year ago. That is strong, and is a result of pricing increases, as well as lots of work by management to cut costs. For the full fiscal year, gross margin was 51.0% compared to 49.1% a year ago.

The work on expenses has been beneficial, but selling, general, and administrative expenses were up 22% in the quarter. We would like to see better cost controls there. However advertising was down by 3% from last year.

Overall, net income was $16.6 million, an increase of 12% from the prior year fiscal quarter. EPS rose to $1.21 from $1.08 a year ago and were in line with estimates. While this growth is strong, in and of itself it still does not justify the premium to earnings generally speaking, but the market is never wrong. As such, the market has priced the stock where it feels appropriate, and we see neither big upside or downside from these levels. Thus we will hold the stock.

Looking ahead

The company is growing sales and earnings. There is a nice dividend here as well. The company is buying back shares. It has increased prices and is working on international expansion. As we look to the 2024 fiscal year the company sees net sales growth of 6-12%, but we think you see 8-12% as more likely. The company tends to underpromise and overdeliver, so the market may be pricing some of that into the stock which by traditional accounts is richly valued. Again, gross margins have been on the rebound. Margins are expected to be 51 to 53%. You can expect net income of $65 million and $70 million, which will translate to EPS from $4.78 and $5.15. If we hit the mid point here of $4.97, that would be just 3% growth in EPS from fiscal 2023. So you can see, the multiple certainly raises eyebrows, but, the market has long valued the company at these levels. We think it remains rather range bound in the near-term, so we continue to hold.

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