The Limited Moat Of WD-40 Company: Is It Worth It?

| About: WD-40 Company (WDFC)

Summary

WD-40 Company is an amazing company with good margins, low debt and high ROE. EPS and dividend also have been increasing throughout the years on top of its recognizable brand.

WD-40 has high brand awareness but brand alone is unable to secure a high volume of sales. Sales volume comes on the back of substantial costs.

Share repurchase and dividend costs are more than the company's operating cash flow. In order to finance the programs, the company has taken on a seemingly redundant $150 million credit facility.

Many good things have been said about WD-40 Company (NASDAQ: WDFC). It is a profitable company with a good margin, low debt and a good brand. It has been buying back its own shares and issuing good dividends for a few years.

The company has a recognizable brand and has been expanding, launching WD-40 Bike Product Lines, a new set of products targeting the cycling community in 2012. The new product line has been performing reasonably well since its debut, competing with more established cycling products brands.

The WD-40 Company also sells some home care and cleaning products, which makes up a small portion of their entire inventory.

Limited Moat and Risk

For almost 40 years, the WD-40 Company sold one product, the world famous multi-use lubricant, which is synonymous with the WD-40 shield logo. The WD-40 logo is the single largest moat the company possesses.

The strength of the WD-40 brand is evident when they are able to charge a higher price than competitors. It is noted in the annual report many times that despite other intangible assets such as patents, the brand is the one that matters.

It is noted in the annual report that existing and new products competes heavily on product performance, brand recognition, price, quality, advertising, promotions, merchandising and packaging. The multi-use lubricant, which generates most of the company's revenue, is described as a world leader among multi-purpose maintenance products by the WD-40 Company. Although it is a "world leader" among lubricants, product performance can be subjective among consumers.

With the WD-40 Company having a market capitalization of $2 billion, the ability to charge a higher price than competitors and arguably being the most recognizable lubricant brand, it is easy to believe that the company has cost advantages.

It is noted in the annual report that raw material costs would hurt the company's finances. This cost primarily fluctuates according to crude oil prices. The company has benefited from dropping crude oil prices in recent years, but the company will suffer when crude oil prices increase. It is noted in the annual report that when that happens, there is little chance of the company being able to raise prices; therefore, the company would have to absorb the increase in cost.

The WD-40 Company definitely has a moat for the brand, especially when the brand allows them to charge a higher price. However, I believe that the brand has a narrow moat. Similar to its brand, I believe that the company has a cost advantage as a moat; however, it is a narrow moat. This is because despite the recognizable brand, the WD-40 Company is unable to raise prices accordingly to inflation and sales come at a substantial cost.

It was noted in the annual report that the company also suffers from key personnel risks.

Strange Debt

The WD-40 Company has taken on $150 million debt in the form of a credit facility. Some of the money has been used for share repurchase and the debt will be serviced using income from operations. The company has warned that more debt may be incurred for acquisitions or other activities. Therefore, there's a possibility dividends are suspended in the future.

The company has announced a $75 million share repurchase and $21 million dividend issuance on the back of $55 million of operating cash flow. As explained above, debt was used to return capital to shareholders. However, this comes across as strange. Why borrow to return? Why does the company spend more money than it makes to repurchase shares? Not to mention issuing dividends at the same time. Why is the company buying back their shares at such high P/E?

The activities are not hurting the balance sheet of the company now. However, it is definitely strange.

Share Price and Risk

Trading at a price of $115.08, this price represents a P/E of 34.22 and a PEG 4.67, which is an insensible price to enter using traditional valuation methods.

With a dividend of $1.52, it represents a dividend yield of 1.32% at the current price. Definitely not a sensible price to enter into for a dividend play.

Conclusion

There's no doubt that the WD-40 Company has a good balance sheet and is expanding. The company can be attractive to hold for dividends and growth. Much praise has been given to the company and justifiably so.

The company has recently started risk-taking behavior such as taking on debt for share repurchases and possibly taking on more debt for dividend issuance. For now, the debt is rather insignificant in relation to the balance sheet and should not harm the company's prospects. If the current behavior escalates to a larger extent in the future, it could be a warning sign.

The main moats of the company are brand and cost advantage, albeit narrow moats. The company has key personnel risk as well as the inability to raise prices. With the stock price trading at $115.08, which represents a P/E of 34.22 and a dividend yield of 1.32%, the price is too expensive for the moat the company has.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.