Description

There are two excellent write-ups on WDFC already on VIC where you can find good background. The company has changed little in the past 5+ years.

We've been reticent on this name for many years, but believe it is a finally set up to be a decent short. The most problematic aspect of shorting WDFC has been the steadiness of the business in a low interest rate environment and no apparent catalyst for a rerating. That could change over the course of 2021 for the following reasons:

1. Reopening - After years of LSD top-line growth, WDFC delivered a monster revenue increase in the past quarter of +26%. This once-in-a-lifetime growth bump will almost certainly revert as economies reopen in one to several quarters' time. This is not eCommerce, where sticky customer acquisition has been permanently pulled forward. This is people stocking cans of household oil in their cabinets. When they stop furiously renovating their homes and fixing their bikes, demand should come back down.

2. Commodity inflation - Petroleum-linked ingredients represent 35% of COGS and are affected by price-indexation of these chemicals to crude. The relationship is far lower than 1-to-1, but nevertheless, rising crude prices may represent up to several points GM compression if oil prices remain elevated or continue to rise. Pricing flows through the income statement on a 90-120 day lag.

Per historical results, impact of oil prices and aeresol cans on GM:

FY Aug 2020: +0.8%

FY Aug 2019: -1.1%

FY Aug 2018: -1.0%

FY Aug 2017: -1.0%

FY Aug 2016: +2.4%

FY Aug 2015: +1.6%

FY Aug 2014: +0.8%

Crude went from $100's to the $30's from 2014-2016, then rebounded into the $70's into 2020 before crashing during COVID. Concurrent and related currency impacts are harder to assess, but have historically damped the effects.

Historically, WDFC has been able to pass through costs with price increases, but having a commodity headwind at the same time as demand is shrinking may result in at least a few quarters of GM pressure. 

3. Interest rates - Consumer staples should in theory face pressure from rising rates. At a less than 1% dividend yield for a company that may soon revert back to a slow growth, the attractiveness of holding such a bond proxy should be inversely correlated with reflation fears.

Conversely, the mostly sleepy investor base may continue to designate this company a defensive, inflation-protected vehicle. And passive flows/low turnover owners may be slow to adjust their positions. This stock is the opposite of a trading football (despite big price move in the past 6 months, trading is anemic compared to peers of similar MC), so any rerating may take time.

4. Factor exposure/valuation - Multiples are stretched at 50x+ forward earnings. While in and of itself, valuaton not a good reason to short, yet it has been challenging to find shorts that can dampen the factors that we want to address in our portfolio without being exposed to other factors we'd prefer to avoid or having to pay significant carry. WDFC strikes a reasonable balance of catalysts and factor exposure.

The company uses its cash flow to buy back shares and pay dividends, not pave the way for growth, so in theory they should be valued on cash flow generation. FCF yield is generously in the range of 1%-1.5% in a normalized environment. What's the right valuation? Doesn't seem to matter right now, but if it traded back to pre-COVID levels, that's $190. At 2% div yield, that puts WDFC at $140. At a reasonable forward P/E of 20x (last traded here in 2012!) that's a $100 stock. If we do see GM compression (which is not a given), you can come up with additional, potentially gruesome downside scenarios, but we think the company has proven its ability to pass through costs and investors will recognize this.

Risks:

Reopening may be delayed.

Macro goes othe way.

While management has been forthright that "isolation renovation" is a big driver of their gains, they have also made efforts to deliver product extensions successfully and to expand overseas. It is possible trialing has led to permanent uptake for these brand extensions or improvement overseas demand and therefore proven the untapped value in the brand.

Given home improvement is still comping 25% in January, consensus for Q2 ending February for 14% YoY sales improvement may be too low. There is likely to be 1-a few more quarters of good comps until vaccines get people back out of the house. Guidance for the year ending Aug 2021 may be too conservative as well. It feels like a few more Qs or growth are already embedded in the price, and stocks have been less and less sensitive to COVID beats. Still, this is a risk in today's bizarro environment.

Technicals - <10% SI, but does not trade w/ high volume so has high days to cover. This investment is not appropriate for big funds, despite a misleadingly healthy market cap. The surprising lack of volume even during earnings reports makes this one tricky and susceptible to overt of inadvertant manipulation, but that could work both ways.

Well run company with seemingly staunch (sleepy?) buy-and-hold investor base. Some consider the brand to be extremely valuable and to have untapped cross-selling/licensing potential, therefore deserving of a massive intangible value premium.

Prior attempts to short on VIC have not worked well. On the other hand, high multiple consumer staples stalwarts like BF.B and MKC have begun to plateau or taper, do maybe there is hope.

Catalyst

Reopening reversion

Oil

Interest rates