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WD-40's Valuation Defies Logic

By Lee Samaha - Oct 31, 2020 at 9:00AM

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The company is benefiting from the COVID-19 pandemic, but on a risk/reward basis the stock looks overvalued.

Some stocks seem to have a set of valuation characteristics of their very own, and WD-40 (WDFC -0.25%) is definitely one of them.

Like other companies with exposure to the home improvement sector, WD-40 had a very strong August-ended quarter. In nutshell, global stay-at-home measures have encouraged a shift in spending toward DIY and spending on the home. However, WD-40's valuation looks more up than events would justify and investors need to carefully consider buying into the stock at this level.

A spray can held by a glove-clad hand

Image source: Getty Images.

Before getting into the details of the company's operations, let's pause for a moment and consider the hefty valuations that WD-40 now trades at. Whether it's enterprise value (market cap plus net debt) to earnings before interest, taxation, depreciation, and amortization (EBITDA); price to free cash flow, or price to earnings, WD-40's valuation is expensive.

WDFC EV to EBITDA Chart

Data by YCharts

Three reasons to be cautious on WD-40

My key points are as follows:

  • The stay-at-home measures have given a boost to sales in Europe and the Americas, but there's no guarantee they will continue, and before the pandemic hit, the company was tracking behind its long-term aims.
  • The company's long-term aspirations are partly contingent on growth in emerging markets, but its Asia-Pacific region sales continue to disappoint.
  • Management's lack of guidance is illustrative of the level of uncertainty still in the marketplace.

A temporary boost?

WD-40's fiscal year finishes at the end of August, so the fourth-quarter earnings refer to the June to August period, with the third quarter being March to May. In this context, it's not difficult to see why third-quarter sales were down 14% year over year -- they came in the middle of the heaviest lockdown period.

However, people eventually started spending on their homes in a phenomenon described by WD-40 management as "isolation renovation." The company's sales bounced back and grew 5% on a year-over-year basis in the fourth quarter, led by a whopping 15% increase in Americas sales and 18% in the Europe, Middle East, and Africa (EMEA) region. The question now is whether this will prove sustainable.

It's very hard to answer that question, because it's far from clear how the pandemic will play out. One thing we do know is that before the pandemic spread out of China, WD-40 was having a hard time tracking management's aim for $700 million in sales in 2025.

Let's put it this way: Sales in 2019 were $423 million, so WD-40 would need to grow sales by 8.7% per annum in order to hit the $700 million target at the end of 2025. To put this figure into context, sales were flat in 2017, grew 7% in 2018, and 4% in 2019. Meanwhile, management started fiscal 2020 forecasting full-year sales growth of 3% to 7%.

Asia-Pacific sales weakness

The following chart shows WD-40's sales by region. As discussed above, the Americas and EMEA regions bounced strongly due to "isolation renovation." On the other hand, Asia-Pacific actually got worse, despite China's economy opening up at a much faster pace.

WD-40 sales growth.

Data source: WD-40 presentations. YOY = year over year.

Discussing the matter on the fourth-quarter earnings call, management put it down to a lack of a DIY culture in the region. In addition, management said that it saw relatively less inventory restocking in China, and the company was coming up against a tough growth comparison from the 22% growth reported in the fourth quarter of 2019.

That's fair enough, but it doesn't change the fact that Asia-Pacific sales growth has been negative for four quarters in a row.

Lack of guidance

Finally, the lack of guidance for 2021 is a reminder that it's still a very uncertain environment. "The COVID-19 pandemic has continued to inject a measure of uncertainty into our business, which makes it very difficult for us to accurately forecast short-term financial results for the company and as a result we will not be issuing any guidance for fiscal 2021 at this time," said CFO Jay Rembolt during the Oct. 20 conference call with analysts.

Recalling that management tends to give pretty wide guidance at the start of its fiscal year, it's somewhat puzzling that there was no guidance given for 2021.

Management's initial full-year sales growth guidance for the last three years has been for 4% to 6%, 4% to 7%, and 3% to 7%. Therefore, the lack of any sort of guidance for 2021 suggests there could be a lot of volatility in WD-40's sales.

Looking ahead

It would be a mistake to be too pessimistic about WD-40's prospects. After all, it's a very good company with a globally recognizable product. Furthermore, management has generated substantive amounts of value for shareholders over the years.

On the other hand, with the stock trading on 53 times trailing earnings, it appears that the market has priced in the most optimistic outcome for the company in the coming years, and there are enough question marks around its performance to warrant skepticism around buying the stock at this price.

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WD-40 Company Stock Quote
WD-40 Company
WDFC
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