WDFC - WD-40: Sell Now Before The Market Rolls Over

2023-04-07 04:09:54 ET

Summary

• Performance does not justify the valuation.
• Earnings are falling.
• Margins are nowhere near the long-term 55% target.
• As we have guided our investors, this market is set to fall hard, and WDFC will not be spared.
• We have owned it for generations but this is a short-term sell.

We have long owned the WD-40 Company ( WDFC ) stock, in fact it has been a generational hold. But right now, the stock is a sell. Make no mistake the stock's valuation has been stretched for years. While shares have fallen far from all-time highs, the stock is simply overvalued. We love that this stock has slowly grown over the years and has paid a handsome dividend that continued growing over the years. However, it only yields 1.9% here at about $180. While this stock will remain in our ports given its a generational name, we think the growth outlook, while stable, is simply expensive in a market that is looking more and more like it is going to sell off. We believe you should be selling stocks in this environment. While WD-40 products are largely insulated from a recession, they are not immune. Consumers could easily choose to forgo routine lubrication, or put off taking care of that squeaky door. The company has perked up with pricing power thanks to inflation but the fundamentals of the company are weakening in this environment.

Performance of the company, while admirable, even with the pressure on companies globally, just does not justify the premium of 346 FWD EPS. WDFC stock has been priced for rapid growth for years now. The valuation is absurd for single digit sales growth and anemic growth earnings. Margins have only been preserved thanks to inflation allowing price increases, and some cost cutting. We think this market falls and takes the stock to sub-$150 here. The just reported earnings were upbeat but the outlook is murky. In this column, we discuss the strengths and weaknesses of the fiscal second quarter.

Top-line growth

It is great when a long-term holding is regularly increasing sales. In Q2, on an absolute basis, sales for the fiscal fourth quarter were $130.2 million, up just 0.2% from the $130.2 million last year. We were expecting sales around $129 million, so this was actually an upside surprise. This also surpassed consensus by $0.68 million. We thought sales would fall as demand has been mixed. Overall we believed the company's lubricating products would see more and more online sales and that brick-and-mortar sales would be about flat, with regional weakness in Asia. Let us discuss

International business soft, America was strong

WD-40 has done well with its international business. If we look at the sales on a constant dollar basis, net sales for the quarter were much higher. Controlling for currency, sales were up to $135.7 million overall. Sales volumes were actually pretty weak, but pricing helped. We have been seeing growth in the Americas but sales fell in Asia-Pacific, and Europe (or EMEA), mostly due to currency issues. Overall, net sales by location for the quarter were 48% in the Americas, 36% in EMEA, and 16% in the Asia-Pacific region.

Sales in the Americas increased 25%, driven by a solid 22% boost in maintenance sales. Sales were up 10% in Canada, and they increased 3% in Latin America. This was strong growth, and the company was both promotional while also increasing their prices. The company has also seen supply chain improvements too, which helped. Net sales in EMEA dropped 13%, which was primarily due the strong dollar. If we control for the dollar, sales still fell 4%. Volumes were down as were direct market sales. It was disappointing, at best. In Asia-Pacific, sales were down 4% from last year. On a constant dollar basis, Asia-Pacific would have fell 1% compared to the prior year mostly on the back of lower sales of maintenance products in the Asia-Pacific distributor markets, which fell 11%. Australia was a bright spot with sales up 6% but in China sales have remained constant which was surprising with the country reopening for business. Thankfully price increases not only boosted the top line above expectations, but they helped margins a bit too.

Margins weakened

The current inflationary environment has severely disrupted the company's ability to maintain and achieve its long-term 55% gross margin target. There are simply too many increasing expenses including labor, input costs, and administrative costs, though the company gas worked to decrease its selling costs. That said, Q2 gross margin was 50.8% compared to 50.4% in the prior year fiscal quarter. Year-to-date gross margin was 51.1% compared to 50.6% in the prior year fiscal period. The work to reduce expenses has not paid off. Selling, general, and administrative expenses were up 8% in the second quarter to $37.7 million compared to the prior year fiscal quarter. Year-to-date selling, general, and administrative expenses increased 6% to $77.7 million compared to the year-to-date results last year.

Making matters worse, earnings are deteriorating. Net income was $16.5 million, a decrease of 15% from the prior year fiscal quarter. Year-to-date net income was $30.5 million, a decrease of 20% from the prior year fiscal period. EPS fell to $1.21 from $1.41 a year ago. Ouch. Year-to-date EPS is $2.23 compared to $2.75. That is simply not good enough. The outlook just is not strong.

Looking ahead

Folks, it pains us to say this, but in the short-term, this stock is a sell here. EPS is forecast to be $4.90 at the midpoint for this fiscal year. This is 36X FWD EPS. Earnings are just not good enough (and falling). Sales will rise single-digits this year, and the company is repurchasing shares. However as we have been guiding our members regarding the market, we see a substantial selloff ahead. We have positioned for success, and right now, you can raise cash by selling WDFC because shares should fall not only on this guidance but on the broader macro picture.

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