WD-40 Doesn’t Fit Most Portfolios at Current Valuation (NASDAQ:WDFC)

My last article was about WEG (OTCPK:WEGZY), an excellent Brazilian company that stands out for its growth track record, solid moats, and very positive profitability metrics, which is why it trades at a multiple well above companies. as Microsoft (MSFT) and NVIDIA (NVDA).

The WD-40 Company (NASDAQ:WDFC) has some similar characteristics. It has clear competitive advantages, a very good growth track record (with a CAGR of almost 6% in revenue) and a ROIC of 24%. The double-edged sword is that all of this is built on one product, WD-40. This product is known worldwide and used in various industries and as it is well established it adds a vision of resistance.

At the same time, the company becomes dependent on this product and the ecosystem built around it, and although the risk is somewhat distant and intangible, it is still a risk. All this is compounded by an unattractive valuation, which is even worse than WEG’s and with less growth.

That said, despite being a good company and compounding its financials, its valuation makes the outlook for shareholder returns low, making WDFC stock a “sell” in my opinion because of the opportunity cost.

The WD-40 company has a strong brand with a solid business model

Even if you don’t work in industries that need WD-40, it’s hard not to know about WD-40. Its product is multi-functional, used by both professionals and amateurs to protect, lubricate and clean a list of things. This brand strength is one of the factors that the company itself puts on the “Why to invest” page, also positioning it as a brand leader in the category.

Not only that, but its business model has other advantages, such as being asset-light, which manages to generate a lot of cash and still has room to maintain a high return on invested capital (over 20%). Over the past 10 years, the average return on investment has been 21%, with some of the worst periods reaching 16.6%.

Over the past 20 years, WD-40 has been able to consistently grow its net income by building on the excellent work of expanding into new industries and geographies, expanding into other product lines, and passing on price increases to customers, CAGR on 5 years. of revenues is 6.5%, a level that is not so high, but it attracts attention for its consistency. What’s even more interesting is that the company did this with basically an ecosystem around a single product, WD-40, which if you count WD-40 Multi-Use and Specialist accounted for 90% of all revenue in America , while the remaining 10% are other product lines focused on maintenance or home care and cleaning.

From this income, the company is able to make a good net profit and generate a good cash flow. The net income margin has decreased in recent quarters, meaning that the net income has remained flat even as revenues are increasing, although it is still at an interesting level. The free cash flow margin is approximately 17.7%, with free cash flow improving in recent quarters and highlighting the low need for capital expenditures. In the last 12 months, while revenue was $575 million, CapEx was just $5.58 million, highlighting the asset-light business model.

In short, the company manages to generate a good and sustainable result through its clear long-term competitive advantages, such as its recurring use, category-leading product, which is very well established and still protected by trade secret.

WD-40’s growth may be slow, but it is steady

The WD-40 company has exciting prospects for the coming years. Even though it is already well established and present in most parts of the world, there is still room for reasonable and gradual growth. The company lists four main avenues for growth, which are geographic expansion, accelerating premiumization, growing the WD-40 Specialist line, and finally Turbo-Charging Digital Commerce. This seems quite feasible based on the company’s track record, as it should allow for improved margins with better digital efficiency, scaling into new regions and the like.

However, it is more likely that this increase will not be so large when analyzed on a consolidated basis. Its revenue is already close to $600 million, and without new product lines or a truly transformational innovation, it will be difficult to achieve double-digit growth for long in its core markets. On the other hand, as it is the company’s own target in the EIMEA and APAC region, growth is likely to be closer to the low-double digits.

In any case, when consolidated, the company’s target is something very similar to its historical revenue CAGR: mid-high single-digit growth.

It’s worth noting that despite the “A” in the growth grade, the company ends up with projections for some metrics below the sector median, such as diluted (forward) EPS growth of 5.08% versus the market’s 6.96% and Forward EBITDA of 6.03. % vs. 6.07% in the market. But it wins in forward earnings growth, at 5.94% versus 3.29%.

If consistent, this mid to high single digit growth should not be underestimated in the long term, because by compounding income at this rate and consistently, it is already possible to reach very high levels and yet with a high level. degree of security due to the solidity of its business model and product.

The price of WD-40 is too high for the growth rate

The bad part of the thesis is definitely the rating and that makes the rating sell. Consistent revenue growth at a rate of 6% or even 8% is quite interesting, especially if we consider possible positive surprises or small margin advances. But that goes away when we see that WDFC’s current share price is already pricing in that and a bit more.

NTM’s price-to-earnings ratio is currently 46x, compared to its average of 36x over the past 10 years. NTM’s EV-to-EBITDA isn’t that different either, at 31.2x versus the 24.8x average over the last decade.

Historically, WDFC shares have not traded at low multiples, consistently trading above the market and other components. But it’s interesting to note how, over the past 20 years, the NTM price-earnings gap has widened when comparing WD-40 to the S&P 500 (SPY) and other companies that I believe have clear competitive advantages and the ability to advanced at a steady pace, such as S&P Global (SPGI), Microsoft, Visa (V), and Coca-Cola (KO).

With a DCF proxy model (using net income instead of FCF for simplicity), it is also possible to find that the market incorporates some optimistic market assumptions. Given ~11% revenue growth over the next few years, ~1 percentage point net income margin growth, and 7% terminal growth (which I consider pretty high), we’d still be overvalued by 4% in case of discount at a rate of 10%.

Of course, this model is only an approximation of a Reverse DCF model, but it is already able to convey that the market adds large short-term growth and either adds large terminal growth or reduces this flow to a low discount rate, rewarding quality its business model. Either way, the result is that the price to be paid for quality is too high and ends up squeezing shareholder profitability.

Could the results be even better than expected? Yes, but I wouldn’t pay such a high premium to see it because there are companies with as good a business model (as some of the ones mentioned) and that also have growth prospects for years to come, which generates a high opportunity cost. .

conclusion

Given the sections above, I would summarize the WD-40 company as an excellent single product (or product ecosystem) company. Its moats are wide, and its iconic brand, along with its power of scale and usability, ends up mitigating the risk of competition and the very dependency of being a single product.

On the other hand, all of this ends up being overshadowed by a valuation that doesn’t match its future growth, which should be steady but in the mid to high range, while WDFC shares trade at more than 46 times estimated earnings. the next 12 months. That’s why I think it’s hard to find room for WD-40 Company in a portfolio at current prices because the opportunity cost seems too high and other alternatives are just as good or even better, although I recognize the high quality of the business.