Even though WD-40 Company (NASDAQ:WDFC) beat revenue estimates and hit analyst earnings targets for the quarter, the company’s stock declined 7% the day after it announced Q1 2019 results. That isn’t a great start for investors hoping for a repeat performance of last year. Based on these results, what management is projecting for the next several years, and how the stock is priced today, a stock price decline isn’t that absurd. Let’s take a look at the company’s most recent results and why investors may be leaving this stock despite its meeting expectations.
WD-40: By the numbers
|Metric||FQ1 2019||FQ4 2018||FQ1 2018|
|Revenue||$101.3 million||$102.6 million||$97.6 million|
|Operating income||$16.4 million||$19.8 million||$17.1 million|
|Net income||$13.2 million||$21.6 million||$12.6 million|
This past quarter was tangible evidence that the corporate tax cuts are having a direct benefit on a company’s bottom line. Even though WD-40’s operating income was down slightly compared to this time last year, net income was up 4.7%. The company was able to juice its earnings-per-share result a little higher thanks to management’s regular share repurchases. Over the past decade, the company has reduced its share count by 16.6% with consistent buybacks.
Sales this past quarter were more or less in line with what investors should expect long term for this company. Even though WD-40 faced some sales headwinds in its Asia-Pacific region, as well as continued declines from its homecare and cleaning products, it was able to more than offset those losses with strong growth in its Europe/Middle East/Africa region and its specialty product business.
The thing that investors should watch in the coming quarters is the company’s costs. Gross margins slipped 0.4 percentage points to 55.1%, and its sales, general, and administrative costs ticked up to 32.3% of revenue. Management has said repeatedly as part of its 55/30/25 plan — 55% gross margin, 30% cost of doing business, 25% EBITDA margin — that it needs to keep costs in check. That uptick could be a result of bringing its research and development work in-house with a new laboratory and a short-term increase. It will be worth keeping track of in future quarters, though. With sales growth in the mid-single-digit range, the company can’t really afford for its operating costs to eat into margins.
What management had to say
The wild ups and downs of oil prices has had an impact on the company’s costs in recent quarters. Management even noted that a large portion of its gross margin decline was from higher petroleum product costs. Since we have seen oil prices decline significantly over the past few months, there is a good chance we could see better results in the coming quarters, right? According to CFO Jay Rembolt, investors shouldn’t jump to conclusions too quickly:
[W]e have not updated our guidance to reflect today’s lower crude oil prices because we have not yet determined if crude oil at less than $65 a barrel is an event or a trend. Additionally, it’s important to clarify that even though petroleum-based specialty chemicals make up a significant portion, approximately 35% of the input costs associated with the can of the WD-40 Multi-Use Product, only a small portion of that is directly tied to the cost of crude oil. This is because we do not buy crude oil, we buy custom-formulated specialty chemicals, which have complex cost drivers, including manufacturing region, fixed product costs and distinctive supply and demand characteristics.
You can read a full transcript of WD-40’s quarterly conference call here.
Going to get harder to justify its premium valuation
It’s hard to say exactly why Wall Street didn’t like these results, but one thing was apparent before this most recent earnings report: WD-40’s stock was priced for perfection. It’s hard to justify buying any business, no matter how good, that grows sales at a rate of 4% to 7% annually for 36 times earnings.
From a business perspective, this quarterly earnings report doesn’t really change the investment thesis on the company. It’s highly likely that it will be a slow-growing business that can supplement investor returns with dividends and share repurchases. Anyone owning shares shouldn’t be concerned with these results. For those looking at this stock as a potential buy, though, the stock simply looks too pricey. It’s probably best to wait for a better entry point down the road.