Description

I suggest shorting WD-40 (WDFC), the maker of the iconic “blue and yellow can with a little red top.” As WDFC laps historic price increases and abnormal volume trends, I suspect growth will fall below Street expectations, resulting in little-to-no earnings growth over the past several years. With the stock trading at over 50x the guidance for current year earnings, there’s ample room for downside. Ultimately, I think the stock trades closer to $140, down ~50%.   

The thesis is as follow:

1. WD-40 benefited from a transitory spike in demand during the pandemic.

2. Around the same time, the company executed a significant price hike to offset increased input costs. 

3. The combination of these two factors (pulled forward demand and higher selling prices), should result in lower growth going forward, particularly in 2H’24 as the comparisons normalize. 

4. Bulls are hopeful for a recovery to historical GMs but abnormally elevated DSIs suggest that margins could remain constrained as high costs may still be capitalized on the balance sheet.

Background 

WD-40 is no stranger to VIC. It has been posted 3x in the past and, of course, they were all shorts! The most recent write-up by zipper in 2021 was the most successful pitch and the stock is now inching back up to a similar price, hence why I think may be worth revisiting.

For background, I would refer you to one of the prior write-ups. WD-40 is largely the same, one product company it has always been. The flagship Multi-Use product still makes up the majority of sales. The company has attempted to premiumize via their specialist line and international sales have grown to ~50% of the mix. The earnings calls still cover their “must win battles” and mgmt is still targeting 25% EBITDA margins at some undefined point in the future.

In terms of things that have changed, the company finally threw in the towel on its LT sales target at Q3’23. They were previously aiming for $650-$700m in sales in 2025. Street is now expecting just over $600m. 

The other significant change is that the longtime CEO and CFO both left in 2022. This was interesting timing given elevated pandemic demand, impending GM headwinds and questionable LT targets. It’s worth noting that the new CFO (Sara Hyzer) has never been a public company CFO before. Despite this and shortly after taking the reins, new management implemented the largest price increase ever. This created a lot of noise in the numbers and is yet to fully work its way through the comparisons.

Meanwhile, since the summer 2022, Street estimates for FY25 EPS have come down ~30% and bizarrely enough the stock is up nearly 50%. Bulls think that WDFC has turned the corner and earnings will finally start to grow. I would suggest otherwise. I think Street may be overestimating growth and suspect this will become more clear over the next 12-18 months.

A history of limited growth followed by a COVID boost

If there’s something remarkable about WD-40, it might be how little the business historically changed. From FY10 through FY19, sales increased at just a 3% CAGR. Assuming 1-2% was price, that leaves a meager 1-2% for volume expansion. 

Most of that limited growth in the past was from expanding internationally. During that same period (FY10-FY19), WDFC added $102m in revs, of which the Americas segment only added $14m. Said differently, international was over 85% of the incremental growth.

That all changed during the pandemic. With consumers stuck at home and renovations booming, sales of WD-40 surged. WDFC added almost the same amount in dollars sales in just three short years as it did in all of the preceding ten (added $95m in revs from FY19-FY22 vs $102m from FY10-FY19). 

Most of this increase occurred in FY21 when sales jumped 19%. Unlike the historical periods, almost 50% of this pandemic increase came from the otherwise dormant Americas segment.

For reasons we’ll get to later (spoiler alert: a big price increase), sales have remained elevated and Street is expecting $578m in FY24 revs. This would represent an 8% sales CAGR vs pre-COVID, nearly 3x WDFC’s historic growth rate! Not suspecting anything awry, Street envisions this above average growth continuing and consensus calls for a 7.5% sales CAGR over the next three years.

Profitless growth

Now, what’s particularly odd about this newfound growth is that it has been largely profitless. 

WDFC reported EBIT in FY23 of $90m, only 9% higher than the $82m reported in FY19. Looking at it another way, over the last 6 years (from FY18 through FY24E) sales have increased 43% yet EPS is only up 7%.    

Despite its limited topline growth in the past, WDFC at least exhibited modest but consistent gains in earnings. This no longer seems to be the case. EPS in FY18 was $4.64 and the guidance for FY24 calls for $4.97 at the midpoint. Earnings have been hovering around $5 for the past four years. 

Part of the reason for this is because it has gotten much more expensive to produce a can of WD-40. The primary inputs into the “cost of a can” are petroleum-based products, tin-plate and plastic - all of which increased sharply during COVID. While these input costs have eased somewhat, the cost of a can is still much higher than it once was. Petroleum (WDFC’s largest input), for example, is still ~50% higher than it was in 2019.

A price increase unlike anything before

This rise in costs started to impact WDFC’s GMs in late 2021. GMs declined ~500bps from a peak of 56% in Q1’21 to 51% in Q4’21. Management responded by taking initial price hikes in early 2022 and then announced a second round of 25% price increases later in the year. This was a price hike unlike anything WDFC had ever done before. 

Amazingly, despite the massive price hike, GMs haven’t really budged much. This should tell you something about how significant the underlying cost increases have been. For FY24, mgmt is guiding to GMs of 51-53%, little changed from 51% in FY23.

In total, I estimate that WDFC took ~$135m in pricing over the past two years or roughly a 30% increase in ASPs. Given that total net sales only increased $49m, it’s clear that volume turned negative. As it turns out, demand for WD-40 isn’t inelastic. While bulls might say that this is now behind us, the jury is still out on what type of impact this will have on the business going forward. 

Messy numbers get more normal after Q2’24

The spike in volume in FY21 followed by the unprecedented price increase in FY22 created a significant amount of noise in the numbers. Volume saw big declines in Q3’22 and 1H’23 but also saw unquantified benefits from pre-buy at other points.

Indeed, the numbers are still a bit messy. While Street celebrated the recent Q1’24 earnings as a “sizable beat,” much of the improvement was explained by the fact that WDFC had one more period of favorable pricing left (+3%) and was lapping a comparable quarter (Q1’23) when volume had sunk 16%.

As we move into 2H’24, the comparisons become more normalized and I would expect WDFC to revert back to the low-to-no growth business it always was prior to the pandemic. 

That being said, it’s not hard to imagine a bleaker outcome. Inclusive of the FY24 guide, volume growth is pegged at a ~3.5% CAGR over the past 4 years. This is well in excess of the historic 1-2% that I noted earlier. And this says nothing about the potential negative impact on demand from WDFC ratcheting up  ASPs over the course of the past year.

To get volume growth back to a 1.5% CAGR, unit volumes would likely need to be down mid-single-digits. This would pose a problem because WDFC is unlikely to take further pricing and is currently investing more heavily in systems and people (OpEx slated to be up ~15% this year).

Street clearly thinks otherwise. Revs are expected to increase 8% in FY24 and another 6% in FY25. EPS is slated to reach $6.70 by FY26, nearly 40% higher than FY23.

Bulls would point to the recent Q1’24 earnings result (revs +12% and GMs improving) as a sign that WDFC has turned the corner. However, Q1 was heavily impacted by the year ago comparison and favorable benefits from mix, which are not expected to persist. With this in mind, it’s notable that WDFC did not alter its guidance or expected range for GMs for the remaining three quarters.

Gross margin expansion may remain elusive 

One of the bullish arguments in support of WDFC is that GMs are bound to recover. Indeed, WDFC ended FY23 with GMs of 51%, well shy of the 55% reported in FY19. 

My problem with the GM argument is that DSIs have risen to astronomical levels. Pre-COVID, WDFC consistently had DSIs in the 70 day range. This jumped to 144 days in FY22 and peaked at 179 days in Q1’23. While inventory levels have moderated somewhat, DSIs remain at 115 days (~50% above pre-COVID levels). WDFC uses FIFO accounting.  

Making matters worse, management has noted that the bloated inventory issue relates almost entirely to North America. Recall that the Americas segment is only 50% of sales and historically showed no growth. As such, the implied DSI on only the Americas segment would look even higher.

The significantly elevated DSIs suggest that WDFC has high cost inventory still capitalized on the balance sheet. I suspect this will keep GMs constrained.

Management’s recent comments seem to endorse this view. At Q4’23, mgmt changed their tune and said that returning to 55% GMs would be a “multiyear task” and talked about their 55/20/25 business model objective as a “long-term beacon”, rather than any achievable metric in the foreseeable future. Furthermore, despite a strong GM in the most recent quarter of 53.8%, management kept the FY24 guide unchanged at 51-53%, suggesting that the quarter benefited from transitory mix and timing benefits (particularly in Asia and Europe direct). 

Ample downside with the stock trading near its highs

WDFC has long traded at mind boggling multiples and I do not suggest shorting the stock on valuation alone. However, the stock is up significantly over the past year (>50%) and it’s worth contemplating where it might trade if hopes for renewed earnings growth fall short.

I expect EPS this year in the middle-to-lower part of the guidance range ($4.78-$5.15). Note that if earnings are at the lower-end, it would mark the third year in a row of declines. I further suspect minimal EPS growth in FY25, suggesting a number ~$5 vs Street at $5.86. 

Prior to the pandemic, WDFC (at its quarterly lows) regularly traded at a low-to-mid 20s P/E from 2016-2018. In FY19, its low multiple was 37x in Q1’19. In FY23 it was 31x. Using $5 in earnings would suggest potential value of $100 (25x) to $175 (35x) or 35% to 66% down.

But doesn’t Linda like the stock?

My view on value is in sharp contrast to the most vocal bull on the stock, Linda Bolton Weiser at D.A. Davidson. Linda recently raised her PT on WDFC to $313 using 53x FY25 EPS of $5.90.

A word of caution about Linda and her estimates:

In 2022, Linda based her PT on FY23E EPS of $6.14. This became $6.04 before she switched years. FY23 EPS ultimately ended at $4.83 (21% lower than where Linda started). 

In 2023, Linda based her PT on FY24E EPS of $6.48. This became $5.96 before she switched years. FY24 EPS is currently guided at $4.97 midpoint (23% lower than where Linda started). 

In 2024, Linda started by basing her PT on FY25 EPS of $5.96. This became $5.90. One can only guess where FY25 EPS might ultimately settle but, not to worry, Linda will be onto the next year by then. Bravo, Linda. Bravo!

This report (the “Report”) with respect to The WD-40 Company (the “Issuer”) has been prepared by the author (the “Author”) for informational purposes only. The Report contains certain forward-looking statements and opinions which are based on the Author’s analysis of publicly available information believed to be accurate and reliable. While the Author believes that such forward-looking statements and opinions are reasonable, they are subject to unknown risks, uncertainties and other factors that could cause actual results to differ materially from those projected. The Author has no obligation to inform readers of changes in such forward-looking statements and opinions and no warranty is made with respect to the accuracy or completeness of any of the information set forth herein.

As of the date the Report is published, the Author and/or certain entities (the “Entities”) affiliated with the Author hold a short position in the securities of the Issuer and therefore have a financial interest based on changes in the price of the Issuer’s securities. The Entities may increase, decrease or otherwise change their position in the securities of the Issuer based on changes in market conditions or other analysis. Neither the Author nor the Entities undertake any responsibility to inform readers of changes in such position.

Nothing in this Report constitutes investment advice. Readers should conduct their own due diligence and research and make their own investment decisions.

Catalyst

Earnings disappointments