Prepared by Chris, Lead at BAD BEAT Investing
WD-40 Company (NASDAQ:WDFC) had long been a stock that was overvalued, but the stock has continued to reward us slowly as long-term shareholders. The last time I checked in on the stock, I felt shares would head lower. Sure enough they dipped a few points, but then ramped significantly taking them over $200 now. Talk about a stretched valuation. As much as I absolutely love the company, the valuation is simply unjustifiable here. Not only is once again simply too expensive with the slow growth it is offering, the pace of growth is even in question. Despite being a stock I have personally held for many years, the stock was largely insulated from the recent huge market selloff. I have been selling calls for income, and some of my position has been called away. However, I will remain long and continue to sell calls, but absolutely cannot justify buying here or recommending anyone reading do the same. Performance is going to be tough to predict, and with consumers still really just buying the essentials at this point, it still is likely the company sees pressure over the next few quarters.
Great name with impressive long-term results
Make no mistake here, the stock has been a great long-term name, but now with slow growth and even some contraction, it borderline amazes me that this stock continues to rise. Sure, it rose with the market, lets be clear about that, and many of the same arguments made on valuation still stand today. While I benefit from owning it, generating income from calls and stock sales when called away, I just can’t see buying here for what the company is offering in terms of performance. I say that as a fan of the company and its products.
To keep sales going and to generate revenue growth recently was promotional in nature, and earnings growth was largely a result of tax changes and share repurchases. But now sales and profits are largely declining, and in reality, that was happening before the virus issues. As such, while a long holder, I am not buying more nor recommending new money be committed. Shares have to fall around 30% before they are attractive, provided earnings were to come in flat to slightly down. Simply put shares are overpriced for flat or even declining performance.
That all said, the story is the long-term and it has been tremendous. But even with a great history, right now, performance just does not justify where we are, even moreso than where we were just a few months ago. Yet the stock has risen. I’ll take it, even if it does not make since valuation wise. I think the best choice is to wait. It has been a reliable name for decades, but it may be dangerous to chase the stock lower here. With the company’s just-reported earnings, I will offer my thoughts on the name.
Quarter in context
On the surface, the company is showing some weakness, and we anticipated Asia-Pacific would be weak in the first part of the quarter, while further weakness would then hit the Americas as COVID-19 spread. In China, many distribution channels and factories were closed and the greater population was placed in quarantine for several weeks starting in mid-January. These factors materially impacted sales in the first part of the quarter as many orders and shipments could not take place due to the COVID-19 outbreak. This became an issue in the 176 countries the company does business in. That said, in geographies and trade channels where WD-40 products remained easy to buy, like in e-commerce and in certain countries that were not subject to movement restrictions, the company performed very well in the third quarter.
The headline numbers in Q3 were mixed. The revenue number was about what we expected, and lower, but earnings were ahead of expectations. Let’s dig into the numbers a bit more and offer forward thoughts. At the most basic of concerns, sales are going to continue to suffer.
The top line year-over-year declines were disappointing but expected
For a long-term holding, we want to see regularly increasing sales. With COVID-19 spreading globally, we knew sales would be down just like they were in Q2.
Make no mistake that while there is the occasional downside surprise, or the occasional impact from currency issues on international sales, we believe the trajectory of sales growth had been reliable for many years, but that is now questionable. And yet the stock is ramping up. Just does not make since fundamentally. While I enjoy the gains, I have to be realistic. It is unjustified. While longer-term, WD-40 has both pricing power and is moving its products into new and emerging markets, particularly internationally, sales are down dramatically
On an absolute basis, sales for the first quarter were $98.25 million, down 14% from the $113.99 million last year. We were expecting sales around $97-$99 million, so this was pretty much in line. We believed the company’s lubricating products would sell just fine online but brick and mortar would suffer, which it did. We saw in Q2 that Asia-Pacific sales were disastrous. We expected this disaster to percolate into other regions in Q3, and that happened. This
International business long a strength now weighing
To be clear, WD-40 does a lot of international business, so it is exposed to fluctuations in currency. Depending on exchange rates, this can help or hinder depending on where global currencies are trading.
If we look at the sales on a constant dollar basis, net sales for the quarter were a touch lower. Controlling for currency, sales were down to $100.5 million overall, which were still down from last year.
The growth internationally at least long-term, is one of the key strengths of WD-40 as it is seeing penetration in new markets, but weakness ongoing in Asia and other areas led to pressure. Let’s dig in to understand where the company is seeing growth globally.
With over 170 countries the products are sold in, some markets may overperform, while others may underperform, so this is expected in normal circumstances. Before the virus, the trend of late had been growth in the Americas and EMEA, while there have been declines in Asia-Pacific, mostly due to currency issues.
This time, the impact of the virus was felt, and felt badly. Overall, net sales by location for the quarter were 51% in the Americas, 33% in EMEA, and 16% in the Asia-Pacific region. This was the first quarter in some time where Americas as a percentage of sales grew, but sales fell across the board.
Sales in the Americas decreased 5%. Much of this was driven by a huge 46% decline in Latin American sales. Sales were down 10% in Canada too, while in the U.S. a 1% gain in sales were noted. Net sales in EMEA dropped 27%. This was thanks to lower sales of WD-40 Multi-Use Product throughout the Company’s European direct and distributor markets, which declined 28 and 25%, respectively. These decreases were due to disruptions related to the COVID-19 pandemic in the quarter.
Now in Asia there were mixed results. Sales were down 5% from last year. Again there were lower sales of WD-40 Multi-Use Product in the Asia distributor market, which decreased 33% year-over-year. The decrease in sales in the Asia distributor market was COVID related. Partially offsetting these declines were higher sales in both Australia and China, which increased 16% and 26%, respectively.
Margins had been under pressure the last few quarters, and here in Q3, there was another decline. Gross margin percentage was 54.0% compared to 54.5% in the prior year fiscal quarter. This is another quarter of pressure, continuing the trend lower. We surmise Q4 will also see pressure. What was surprising is that from an operating expense standpoint there were declines in all categories. Advertising expenses fell 24%, while administrative expenses fell 13%.
Net income was $14.5 million, down 20% compared to last year’s quarter, and earnings per share came in at just $1.06. This beat our projections by a solid $0.06. Revenues were about in line but we also thought margins would be in the 53% range, so the margin results helped earnings beat consensus by $0.11.
On a fundamental basis, this stock should be much lower, but markets can be illogical. We really cannot see where earnings are going other than lower for the year after Q2 and Q3. Through Q3 EPS are $2.98 vs $3.39 last year. So they are contracting. A fair estimate may be a decline of $0.50-$0.70 per share this year. That type of contraction suggests the stock should be lower. Even if growth resumes in the next fiscal year, it will be minimal growth, and growth that does not justify a near 40x FWD EPS valuation. While I hold a core position that is hedged, I will say it is not a buy until shares fall back at least $175 here. While the stock rallied with the market, I just question how much more it can run with the reality of performance.
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Disclosure: I am/we are long WDFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.