WD-40 Company: The Coca-Cola Of Lubrication

| About: WD-40 Company (WDFC)

Summary

WD-40's brand gives it a long-term durable competitive advantage.

The company has substantial growth potential.

WDFC is an exceptional company selling below its intrinsic value.

Investment Thesis

WD-40 Company (NASDAQ:WDFC) is a global company that sells multi-purpose maintenance products. Created in 1953, WD-40 has leveraged its superior brand to expand sales of its multi-purpose can and accompanying maintenance products from the United States to across the world. Management's strategy is simple, expand the blue and yellow can with the red top to more consumers across the world and leverage the brand strength to broaden its product portfolio. The result of management's strategy has been exceptional ROIC, steady EPS growth and a generous amount of capital returned to shareholders, making WD-40 an one of a kind company. Despite recent foreign currency exchange impacts, WD-40 still is a growing company that will continue to flourish throughout the ages. Conservatively, I have WD-40's intrinsic value per share at $146.10.

The Products

WD-40 categorizes its products into two categories, maintenance products and homecare cleaning products.

Maintenance Products:

WD-40 Multi-Use Product - A market-leading multi-purpose maintenance product used in a variety of domestic and commercial purposes for over 60 years.

WD-40 Specialty Product Line - Specialty maintenance products including penetrants, degreasers, corrosion inhibitors, lubricants and rust removers geared towards trade professionals. The WD-40 Specialist Line was introduced in 2011.

WD-40 Bike Product Line - Line of comprehensive bike maintenance products launched in 2012.

3-IN-ONE - Multi-purpose drip oil used in a variety of different industrial applications such as locksmithing, HVAC, marine, farming and construction.

GT85 - Multi-purpose bike maintenance products, spray maintenance products, and lubrications sold through automotive channels in the UK. GT85 was acquired in 2015.

Homecare and Cleaning Products:

X-14 - Liquid mildew stain remover and automatic toilet bowl cleaner primarily sold in the U.S.

Carpet Fresh - Room and rug deodorizers sold as powder, aerosol, quick dry foam and trigger sprays. In the U.K. the brand is sold as 1001.

Spot Shot - Aerosol carpet stain remover and liquid trigger carpet stain and odor remover. Sold primarily in the U.S. and Canada, and sold under the 1001 brand in the U.K.

1001 - Carpet cleaner, household cleaner, room/rug deodorizers which are sold in the U.K.

Lava - Heavy-duty hand cleaner products sold primarily in the U.S.

The Brand

WD-40 was developed in 1953 by the Rocket Chemical Company for use in the aerospace industry for rust prevention and degreasing. Today, WD-40 is used in over 2,000 different ways from automotive repair to gardening. WD-40's economic moat is its brand which is known for quality and its multi-purpose use in homes, workshop and factories. Similar to Coca-Cola (NYSE:KO), customers don't go to the store to buy a multi-purpose water displacing penetrating oil, they go to buy WD-40. WD-40 has no competitor that is a real threat to its over half century old multi-purpose can. Because of its brand strength, WD-40 has pricing power; why spend 40 cents less on a can of generic penetrating oil when you can buy the best product that you trust?

The Strategy

Management' strategy is outlined below:

  • Grow the use of WD-40 Multi-Use Product
  • Grow the WD-40 Specialist Line
  • Broaden product and revenue base by leveraging the WD-40 brand.
  • Attract and maintain employees.
  • Operational excellence by optimizing resources, systems and processes.

Let's take a look at the first three goals:

Strategic objective one is to grow the WD-40 Multi-Use Product. Management's goal is to grow the sales of the Multi-Use Product to $600 million globally by 2025; sales of all maintenance products combined were $340 million in 2016. Strategic objective two is to grow the WD-40 Specialist Line. Management believes it can grow the Specialist Line to $125 million in revenue by 2025. The third strategic objective is to broaden the product and revenue base. WD-40 plans to leverage its brand strength to expand its offerings with the 3-IN-ONE, GT85 and WD-40 Bike products.

WD-40's Homecare and Cleaning products serve as harvesting brands; these products will be reduced/eliminated over time. Although they are cash flow positive, management acknowledges that its Homecare and Cleaning products have difficulty competing with the brand strength and marketing power of larger companies like Clorox (NYSE:CLX).

The Results

Diluted EPS CAGR of 7.9% between 2007 and 2016. CAGR sales growth of 5.2% between 2007 and 2016 for maintenance products within all regions, including 10% CAGR for the Asia/Pacific region, 4.4% for the Americas, and 4.4% for EMEA.

Average ROIC of 33.7% between 2007 and 2016 and a current WACC of 5.7%. WD-40 earns on average a spectacular 28 cents per dollar that it invests in its business. For comparison, companies regularly earning a 15-20% ROIC are considered excellent in deploying capital and are generally thought to have a long-term competitive advantage (economic moat) over its competitors.

Average gross margin of 51% between 2007 and 2016. Even when WD-40's primary feedstock (crude oil) skyrocketed in price in 2008, it was able to increase its sales price to maintain a respectable 47% gross margin. Gross margins have continued to increase throughout the last 10 years as WD-40 focuses on its more profitable maintenance products and sunsets its less profitable homecare/cleaning product lines. No true long-term debt; WD-40 lists its revolving credit facility as a long-term liability, but it rarely draws much down from the facility, and has plenty of cash to cover the current portion of the facility that it does draw down. Because of the company's high returns on capital, management is able to repurchase shares while increasing the dividend. From 2007 to 2016, diluted shares outstanding decreased at a compounded annual rate of 2% per year while dividends paid out to shareholders have increased at CAGR of 4%.

Perceived Risks

Foreign Currency Exchange Rate Impact:

40% of WD-40's revenue comes from other currencies. The rising dollar, combined with the plummeting pound and euro, has caused WD-40 to miss recent earnings forecasts. Investors may interpret the earnings misses as stalled growth, but in reality, the impact of foreign currency on the business is normal and doesn't have a great impact for long-term shareholders.

From Q1 2017 earnings transcript:

"…That completes the strategic initiatives updates and so let's move on to the details of our first quarter results starting with sales. Consolidated net sales were 89.2 million in the first quarter down to 3.3 million versus last year. In the first quarter we generated approximately 40% of sales in currencies other than U.S. dollar and changing foreign currency exchange rates continue to be a headwind for us. Translation of our foreign subsidiaries results from their functional currencies to U.S. dollars had an unfavorable impact on sales.

On a constant currency basis total net sales would have been 95.1 million an increase of 3% compared to last year. This is because our net sales were reduced by about 5.9 million due to the strengthening of the U.S. dollar against the functional currencies of our subsidiaries. This is what we refer to as translational related exposure and it impacts reported results from Canada, Australia, China and even EMEA segment. However if we take a close look we see that this reduction in sales was significantly offset by about 4.2 million of translation related impacts in EMEA due to the strengthening of the Euro and the U.S. dollar against the pound sterling.

So net-net, if we remove all foreign currency exchange impacts our consolidated revenue would have been around about 90.9 million, down 2% compared to the first quarter of last year."

From Q4 2016 earnings transcript:

"For the full fiscal year net sales were $380.7 million, which was an increase of 1% from last fiscal year. Changes in foreign currency exchange rates had an unfavorable impact of $11.7 million on consolidated net sales for fiscal 2016. So if we removed all currency related impacts, net sales would have increased by about 4%."

From Q4 2015 earnings transcript:

"Today, we reported consolidated net sales of $378.2 million for full fiscal year, which is a 1% decline from last fiscal year. In the fourth quarter, consolidated net sales were $92 million, which is 6% decrease from the fourth quarter of last year. The impacts of changing foreign currency exchange rates significantly reduced that net sales in fiscal year 2015. When you take, both translation and transaction exposure into consideration, changes in foreign currency exchange rates reduced our total net sales by around $16 million for the full year."

Long-Term Growth of the Core Maintenance Products

Although the past isn't an indication of the future. WD-40 Company has been able to consistently grow sales of the blue and yellow can with the red top since 1953. I believe based on WD-40's brand and performance throughout history that it will continue to flourish in the immediate and distant future as more and more people are exposed to its maintenance products throughout the world. There is no true substitute for WD-40; people in 2095 will continue to grab WD-40 for their multi-purpose needs as they did in 1953.

Valuation

In order to determine the intrinsic value for WDFC, I'm going to establish a range using two different scenarios.

Scenario #1: Tepid FCF Growth & Quick Maturation (Terminal Value) of Cash Flows

Estimated Scenario #1; Share Price: $126.77

Assumptions:

  • WACC of 5.7%
  • FCF growth of years 2017-2021 of 2%
  • Terminal value (mature perpetuity FCF) of $89 million
  • Year 2025's sales of $741 million (conservative estimate based on management's guidance)
  • FCF as a % of sales of 12% terminal value growth rate of 1.5%
  • Below average inflation and well below the average global GDP growth rate

Scenario #2: Decent FCF Growth Rate & Longer Maturation (Terminal Value) of Cash Flows

Estimated Scenario #2; Share Price: $165.44

Assumption:

  • WACC of 5.7%
  • FCF growth of years 2017-2021 of 3%
  • Terminal value (mature perpetuity FCF) of $104 million
  • $866 million in sales
  • FCF as a % of sales of 12% terminal value growth rate of 2%
  • Slightly below average inflation and below the average global GDP growth rate

I believe the intrinsic value lies closer to the $165 share price, but to be ultra conservative, we will use the median value of $146.10 as WD-40's intrinsic value.

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. I have no business relationship with any company whose stock is mentioned in this article.

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