The recent results from universal lubricant and degreaser company WD-40 (NASDAQ:WDFC) saw the market react by selling the stock off, but if the bears are right there could be more to come. Alternatively, the bulls will see it as a buying opportunity. Let's take a look at the cases for and against buying the stock.
The bullish case for WD-40 stock
There are three key arguments that have excited the bulls over the stock:
- The company's sales are largely recession-resistant as they relate to servicing cars, DIY, and hardware -- activities that aren't that economically sensitive.
- The fall in the price of oil should reduce the company's costs, so gross margin should improve.
- Long-term investors will focus on the company's progress in reaching its 2025 strategic aspirations and not be overly concerned with a few weak quarters.
There's some merit in each of these arguments. For example, on the recent earnings call, CEO Garry Ridge argued that the sales decline during the recession in 2008 "was primarily because of the strengthening of the US dollar against the pound" with CFO Jay Rembolt adding, " Actually, we had a shortfall in the US. We actually -- in local currency or in source currency, we were -- we had growth in EMEA. But it was wiped out because of the headwind from foreign currency exchange."
Moreover, the auto parts retailers through which WD-40 sells a lot of product, like O'Reilly Automotive (NASDAQ:ORLY) and AutoZone (NYSE:AZO), are traditionally seen as recession resistant. Consumers tend to hold off buying new cars in a recession in favor of running older ones that need more servicing.
As for the argument that costs could come down, WD-40 has previously outlined that 33% of the cost of a can manufactured in the U.S. comes from "petroleum-based specialty chemicals," with 19% from plastic and 33% from the cost of the can itself. You could argue that all three of these components could see cost reductions in the current environment.
Finally, the company has an excellent track record of growing sales, generating good operating margins, and an enviable return on equity rates. All of these things stand it in good stead to hit its long-term aims.
The bearish case
The bears are probably willing to accept some of these arguments, but the points made need to be put into context.
First, WD-40 may well have some recession resiliency attached to its products, but that doesn't justify the valuation premium the market is still giving it. For example, here's a look at a common valuation metric, namely enterprise value (market cap plus net debt), or EV, to earnings before interest, taxation, depreciation, and amortization, or EBITDA.
For reference, the total market EV/EBITDA multiple (excluding financials) in January was 13.8 times EBITDA. Not only is WD-40's multiple significantly in excess of that figure, it's also at a massive premium to the auto parts retailers (O'Reilly and AutoZone are also arguably recession-resilient businesses) and hardware stores that it sells through.
Second, the recent second-quarter earnings report came with a very disappointing gross margin performance. Chief operating officer Steve Brass noted that WD-40 buys "custom formulated petroleum-based specialty chemicals, which have complex cost drivers, including the manufacturing region, fixed production costs and distinctive supply and demand characteristics," and argued that "we estimate only a small amount of the total costs to produce a can of the WD-40 Multi-Use Product directly correlates to the price of a barrel of crude oil." In addition, gross margin was negatively impacted by an unfavorable sales mix.
Finally, according to the author's calculations, the compound annual growth rate (2019 to 2025) of revenue needed to hit the company's aspiration of $700 million in sales in 2025 is around 9.2%. Even before the COVID-19 pandemic hit WD-40's ability to distribute in the Asia-Pacific region, the company hasn't been anywhere near this rate on a consistent basis in the last couple of years.
Ridge appeared to back off these targets on the earnings call, blaming the COVID-19 crisis by saying, "The timing of our 2025 aspirations may be delayed," but the reality is WD-40 looked to be behind these targets anyway.
The bottom line
All told, WD-40 stock trades at a significant premium that doesn't appear to be justified considering how it's tracking toward its 2025 aspirations. The idea that lower commodity prices will boost gross margin is questionable, and there are other recession-resilient candidates that trade on significant valuation discounts to WD-40.