WD-40 – A DIY Essential
The WD-40 Company is a business which operates in 2 main product segments; maintenance products, and homecare & cleaning products. Both products are sold worldwide in over 172 different countries, through multiple different channels. Products are primarily distributed through mass retail, home center stores, warehouse club stores, grocery, and hardware stores along with various automotive parts and dealers. Maintenance products account for 90% of net sales, this includes their most well-known product, WD-40 Multi-use Product (MUP). Homecare and cleaning products are responsible for the remaining 10% of net sales. As of writing, WDFC is trading at roughly $162 a share on the Nasdaq exchange.
WD-40 Company is currently focusing on creating organic top-line growth to their existing product line. The company’s current goals are to achieve an 8% net sales growth per year, the analysis shows that this is an overly optimistic goal based on previous years growth. By discounting cash flows with base case assumptions shows that WD-40 is slightly below fair value. When comparing different cases for a DCF valuation WD-40’s current price does not offer a large enough margin of safety for WD-40 to be an attractive long position. With a slightly larger discount to fair value, WD-40 would be a quality value investment. The following elements are what drive the investment thesis:
- The maintenance products have the longest history out of the two product groups with the WD-40 MUP being over 50 years old. Over the years WD-40 has built a strong brand with the eyes of the consumers. It is not uncommon to hear WD-40 as the solution to numerous maintenance problems that affect everyone from parents fixing a squeaky hinge at home to professionals working in various industries. This strong brand power and recognition provides value and enables WD-40 to have pricing power in a very competitive market.
- The economic moat around WD-40 is strong relative to how competitive the maintenance and homecare and cleaning product segments are. The WD-40 MUP is a closely held trade secret with no close substitute and therefore is the main revenue driver, to disrupt the WD-40 MUP sales it would require a large upfront investment by competitors with the required skills to properly develop something comparable. The strong brand power always provides a large moat to new entrants.
- The strength of WD-40’s balance sheet also shows that the company has a large amount of flexibility that would allow it to adapt to changing industry environments. WD-40 currently has little to no debt on the company apart from a $154 million revolving credit facility with a low-interest rate. The company has healthy ratios regarding their debt, a current ratio of 1.7 and a debt to equity ratio of 1.1. Wd-40 also shows strong ROE and ROI of 39.2% and 18.5% respectively.
WD-40 Company sells multiple different products that aim to solve problems in workshops, factories, and homes. WD-40 generates revenue in two main segments, maintenance products, and homecare & cleaning products. The main source of revenue is their maintenance products while the homecare and cleaning products are a relatively new addition to the product line up and account for only a fraction of net sales. Revenues are generated in over 172 countries through a wide variety of retail channels.
As previously mentioned the WD-40 Company offers various maintenance products aimed at general consumers and professionals. The maintenance products aim to solve problems in the home and professional settings like warehouses and factories. Along with their multi-use products Wd-40 offers various specialty product lines that demonstrate the company’s pricing power through its brand power. Available in the form of an aerosol spray, non-aerosol trigger spray and in a liquid form available through retail stores, hardware stores, warehouse club stores, automotive parts outlets, and industrial distributors and suppliers. Products are sold globally in over 170 countries. No one customer accounts for more than 10% of net sales.
The main driver of revenues from the maintenance products is units’ sales coupled with unit price. Since WD-40 has strong brand recognition and a strong reputation towards in maintenance products they possess the ability to charge a premium for their products. This is especially demonstrated in their specialist product line that is aimed directly towards professionals who on average consume more of the product per year. WD-40’s main competitive advantage is their brand power and the loyalty that comes with that. The brand loyalty creates switching to off brands that are cheaper harder for the customer to justify since the reputation of WD-40 has a strong historical background and is ingrained in the end consumer.
Homecare and Cleaning Products
WD-40’s product portfolio includes homecare and cleaning products which account for roughly 10% of net sales as of the fiscal year 2017. Products include surface cleaner’s automatic toilet bowl cleaners, carpet fresh, rug and room deodorizers and stain removers. Offered under WD-40, 3-In-One, GT85, X-14, 2000 flushes, carpet fresh, no vac, Spot Shot, 1001, lava and solvol brands. These products sold primarily in North America, the United Kingdom, and Australia.
The homecare and cleaning segment of the company is relatively new in comparison to the maintenance products. WD-40 acquired 3-In-One, Lava, Solvol, 2000 Flushes, X-14, Carpet Fresh and Spot Shot over the period of 1995 to 2004 during the time Gary Ridge was appointed to his current position as CEO in 1997. The brand power that is prevalent in the maintenance products is not applicable to the homecare and maintenance products. This is a reason as to the way the sales for this segment have stay close to roughly 10% of net sales over the years. Operating in a highly competitive market with firmly established competitors it seems that WD-40 is falling to drive revenues higher within the homecare and cleaning segment. With the key driver for revenue growth in this category being pure organic growth in sales, it is difficult to see any real competitive advantage in this segment for WD-40.
Management & Governance
Overall the management of WD-40 seems to be relatively well aligned with shareholders. Both the CEO, Gary Ridge and CFO, Jay Rembolt, have been with the company for over two decades. Gary Ridge was originally appointed CEO in 1997 which was roughly around the time WD-40 made various acquisitions to enter the homecare and cleaning products segment, along with increasing overseas sales. The lackluster performance of homecare and cleaning does not show confidence in smart capital allocation by Gary Ridge. That being said both the CEO and CFO’s compensation is roughly 30% based on company performance. Both executives seemed to be great leaders and have implemented a culture that nurtures organic growth and innovation.
In terms of corporate governance through the board of directors, it seems that the executives have a healthy group of well-qualified board members that provide valuable experience in a diverse set of backgrounds. With directors with extensive knowledge of consumer goods, finance, retail industry experience, executive compensation, and legal expertise, the company has the required pieces for a successful management team.
The base case for the valuation used relatively conservative assumptions when compared to the company’s financial goals set for the next 10 years. The estimate for the fair value of the stock, based on base case assumptions, is a stock price of $180 which is roughly 10% higher than today’s price of 162. The fair value of the company if it were to be successful in reaching its financial targets would have a fair value of $280 based on a 10-year DCF model. With a conservative fair value of $180 and a best-case value of $280, the current price does not offer a large enough margin of safety to recommend an investment at today’s price.
The company has outlined that it has a target of reaching 700 million dollars in net sales by 2025 implies an average year over year growth of 8%. After the analysis of the company and it’s financial performance it is difficult to believe that it will go from roughly growing 1% a year over the past 5 years to growing 8% on average over the next 10 years. Also based on the deteriorating performance of the homecare and cleaning products, the base case DCF valuation used a 10-year growth rate of 5%.
Terminal Growth Rate
For the terminal growth rate, the US Federal Reserve target inflation rate of 2% was used. This was used in both the base case and the best-case valuation to be a conservative estimation that the company would not have real growth after a 10-year growth period.
The discount rate used in both cases was calculated using the traditional weighted average cost of capital method (WACC). Cost of debt used the company’s current interest rate for their revolving credit facility which is the Bank of America prime rate and a normalized tax rate of 30%. Cost of equity was calculated using the CAPM model with a risk-free rate equal to the current 10 year US T-bill yield, which is currently 3.21%. Expected market return used is 7%, along with a beta of 0.53.
WD-40 has expressed goals to increase its margins to have a model that requires an EBITDA margin of 25% of net sales. Depreciation & amortization expenses were set to be 1.5% of net sales in both cases. This is based on the company’s target rates of being 1-2% of net sales, this is reaffirmed but the average over the past 5 years is 1.6%. The EBIT margin in the base case used a 20% margin while the best case used the target 23.5%.
Change in Working Capital
Based on previous results and a historical average of roughly -$3000 this item was straight-lined at -$5000 a year in both cases.
Since WD-40 is a very low capital-intensive company the same rate was used in both cases. The company predicts it will need only between 1 and 2 percent of net sales to go towards CapEx. The rate used in both cases was 1.5% which was backed by a historical average of 1.88%.
Like any investment there exists certain risks that can drastically change the value of the company potentially turning it into a low-quality investment. The following is a list of potential risks that would require following if an investment in WD-40 were to be made:
- The current low-interest rate environment poses certain risks, the main one being that if rates were to increase the interest expenses would eat into the company’s free cash flow limiting its opportunity for effective capital allocation. Since the current risk-free rate used in the DCF valuation is relatively low when compared to normal this could lead to a valuation being far over the true fair value of the firm.
- If events were to take place that lead to the brand power eroding it could cause the company’s competitive advantage to diminish leading to consumers switching to lower cost products causing the top line growth to be well under the projected rates.
- With a company having 50% of net sales happening overseas, there are certain country-specific risks that could lead to a decrease in the firm’s financial performance. These risks include economic and political risks, the impositions of tariffs or trade restrictions, foreign compliance and the effect of foreign currency exchange rate fluctuation.