WD-40 (WDFC -2.10%) stock's valuation has had a mind of its own in recent years. However, the stock has sold off heavily after its second-quarter fiscal 2021 earnings report revealed some significant supply chain difficulties in the Americas region. Is now a good time to take advantage and buy some WD-40 stock? Here's what you need to know.
The second-quarter earnings report and the market's adverse reaction to it must have left some investors scratching their heads. After all, net sales increased 12% in the quarter, and management raised its full-year sales guidance from a range of $435 million to $470 million to a new range of $445 million to $475 million. So what's not to like about it all?
There are quite a few concerns. First, as CEO Garry Ridge noted in the earnings release, "This upward revision is driven primarily by favorable changes in foreign currency exchange rates." In other words, the revenue guidance hike comes down to a factor (exchange rates) that could quickly move against the company. It doesn't come from an underlying improvement in sales.
Second, the company faced supply chain difficulties that negatively impacted sales in the U.S. and, therefore, the Americas region. The chart below shows that the region's sales declined 1% compared to the same period last year.
The issues are significant. During the earnings call, Chief Operating Officer Steve Brass said that third-party manufacturers had been "experiencing increased absenteeism and labor shortages, which have resulted in slower line speeds, capacity constraints, and increased competition for line capacity within the aerosol industry." It gets worse. Brass also noted there were "raw material shortages and transportation bottlenecks."
While it's entirely possible that these issues will get resolved in a quarter or two, it's also possible that competitor products could be grabbing shelf space and new customers while these disruptions are in place.
Margin pressures are coming
The company's margin performance was also somewhat confusing. Management has a gross margin target of 55%, and the performance of 55.4% in the quarter is above that. Moreover, the gross margin increased 180 basis points (where 100 basis points equal 1%) from 53.6% in the second quarter of 2020.
However, many of the factors that contributed to the margin increase will reverse pretty soon. For example, lower costs in petroleum-based chemicals and aerosol cans together contributed 210 basis points to the quarter's gross margin.
However, with the price of oil currently at around $60 a barrel, it's about to come up against some very weak comparisons with the price at the same period last year. Also, the supply chain disruptions are adding to costs as well.
All told, CFO Jay Rembolt said that gross margin could deteriorate "between 200 basis points to 300 basis points from where we are today as we go through the third and fourth quarter."
It's been somewhat forgotten that WD-40 pushed back its long-term revenue growth aspirations last year. The numbers have stayed the same, but the date has changed. Going into the second quarter of 2020 last year, management was aspiring toward $700 million in sales by 2025, but after the earnings report, it changed the timing to "over the long term."
While it's completely understandable that the pandemic would have pushed back its sales aspirations due to the hit in 2020, it's also the case that WD-40 is a beneficiary of the stay-at-home trend. Indeed, its full-year sales guidance of $445 million to $475 million implies a revenue increase of 9% to 16.4%. The problem is, assuming the high end of the guidance for 2021, its sales would have to increase 10.1% a year to hit the $700 million figure in 2025. That's a rate that the company hasn't been anywhere near in recent years.
Whichever way you look at it, WD-40 is not tracking its previous aspirational aims.
Valuation remains sky high
Even after the recent fall, WD-40 still trades on more than 45 times its estimated earnings in 2022. That valuation seems extremely rich for a company that's facing near-term margin pressure and operational challenges in 2021.
Is WD-40 stock a buy?
Despite the recent fall, WD-40's valuation still isn't compelling enough at this price. It's a great company, but that doesn't make it an excellent investment, and cautious investors will want to remain on the sidelines for now.