For more than four decades, WD-40 Company (NASDAQ: WDFC) sold just one product, its chemical formula that people buy for a wide range of uses, including lubrication, rust prevention, and cleaning. Its product line has diversified over the past few years, but the company still traces most of its growth prospects back to that single brand.
The simple approach of marketing WD-40 products around the world has helped the company grow to a more than $2 billion valuation. And shareholders have enjoyed market-thumping gains lately, with the stock rising more than 50% in the past year compared to a 15% increase in the S&P 500. But can that rally continue?
Below, we'll take a closer look at the bullish case for this stock from here.
Image source: Getty Images.
All about the brand
WD-40's impressive operating results reflect its dominant market position and stellar brand. Sales rose by 5% in fiscal 2017, after accounting for foreign currency swings, and improved at a similarly strong rate in the most recent quarter.
The company continues to find ways to increase demand in the mature U.S. market thanks to innovations like its new flexible straw applicator. But the bigger opportunities are in international areas that together account for only about half of all sales today. Revenue in the Europe and Middle East segment is up 13% over the past nine months, compared to a 5% boost in the U.S., after all.
The business is extremely efficient. A gross profit margin of greater than 55% is a consequence of WD-40's trusted brand. And thanks to its limited production and marketing costs, operating margin hovers at around 20% of sales. That translates into a bottom-line profit margin of roughly 15%. And annual growth in earnings per share often exceeds that result thanks to aggressive stock repurchase spending.
Some risks to watch
The company faces its fair share of challenges, too. Despite efforts to diversify into home-care and cleaning products, for example, that division still accounts for less than 10% of the broader business. Sales are down 12% in the segment over the last nine months.
WD-40 is also at risk of posting its second straight annual decline in gross profit margin, given that the metric fell to 55.1% of sales in the fiscal third quarter from 56.3% in the prior-year period. That slump is mainly a consequence of rising raw material costs, so investors can expect to see the management team issue price increases over the next few quarters to protect overall profitability.
Considering its brand strength, I'd wager that WD-40's sales growth pace will hold up well even as the company raises its prices. In fact, management is targeting growth of between 6% and 8% in fiscal 2018, and success on this score would be further proof that the business has a tight grip on its market niche. Those sales gains should produce net income of around $57 million, equating to a profit margin of about 14% of sales.
Wait and see
The key risk for investors in buying a high-performing business like this is in paying too high a price. And that challenge appears to apply here.
In fact, shares today are valued at about 40 times the past year's profits. WD-40's valuation has been as low as 16 times earnings in the past decade, and it has hovered at a P/E of between 20 and 30 since 2014. In my view, that's too rich a price to pay for a company with a healthy but limited growth profile. It's an attractive business, but investors might want to keep WD-40 on their watchlist in case an operating stumble or broader market correction knocks back some of the 185% gain the stock has enjoyed since mid-2013.
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