Spruce Point Capital Management Releases A Strong Sell Resea
NEW YORK, April 2, 2020 /PRNewswire/ -- Report entitled "A Slippery Slope Investment" outlines how WD-40 Company ("WD-40" or "the Company") faces 55%-60% downside risk to approximately $75 - $85 per share. The full contents of the report can be reviewed at www.sprucepointcap.com. Spruce Point believes that WD-40 is widely misunderstood and believed to be defensive, but in reality, is facing both long and short-term secular pressures. With the Company recently upsizing and drawing down 100% of its credit facility, a size 1,500% larger than the previous recession in 2008-2009, we believe a massive hole in its balance sheet has been exposed. Our forensic review and channel checks indicate record bloated inventories, and material financial strain. We believe it will have to drastically reduce its optimistic 3-7% sales target and re-set investor expectations meaningfully lower. Trading near all-time highs and at an unprecedented 6x sales and 27x EBITDA, we believe shares are a horrible risk/reward.
- At the Core, WD-40 is an Oil-Based Lubricant Being Sold at Above Market Prices and Heavily Dependent on its Brand Equity: We believe WD-40 to be a highly promotional business which has been under long-term pressures even before the Coronavirus scare. WD-40 relies on a trade secret, and has no patents, to protect itself in the market place from dozens of cheaper all-purpose and specialty lubricants in a variety of saturated retail channels, and user end markets. WD-40's heaviest users are maintenance and repair specialists, notably in the auto and bike market. A long-term challenge facing it is the electrification of cars, which have fewer moving parts and require less regular maintenance. We believe the product is also coming under increasing regulatory scrutiny. By analyzing changes in its product fact sheet, we see that more disclosures about the hazardous nature of the chemicals contained in the product are being highlighted. WD-40 is not well suited for a world in e-commerce. The Company added a product disclosure that it doesn't recommend shipping the product in the air, and the FAA has added WD-40 to its flammable product list.
- Investors Fail to Understand Changes in WD-40's Business That Expose it to Much Greater Risk Today vs. the Last Crisis: We believe the Company to be far from recession-proof. Late Friday on March 27th, WD-40 drew the remainder of its $150m credit facility. During the prior crisis, it had a small $10m facility that was never utilized. During the same period, sales only grew 33%. We believe this gigantic draw down exposes a major hole and problem with its business. WD-40 is levered only 0.7x Net Debt to EBITDA and projected to generate $30m+ of free cash flow. In our view, WD-40 has no visibility in an economic recession. It missed FY 2009 sales and EPS estimates by 13% and almost 10% at the mid-points, respectively. In FY 2008 it missed sales and EPS by 5% and 13% and the mid-points, respectively. This time around, the economic crisis is greater, and we expect a much larger miss of its targets.
WD-40's business has grown much more international today compared with the last financial crisis ten years ago. Today: 63% of sales are international vs. 52% during the last crisis. WD-40 now obscures country-level revenue detail. However, we estimate the U.K is 37% of total revenues, up from 9% during the last crisis. We estimate that 75% of WD-40's cash is in its U.K. subsidiary. First Brexit, and now a coronavirus scare, has sent the Pound to multi-year lows which we believe has compounded WD-40's challenges. Based on our analysis, working capital to sales is currently 16.3% of sales, almost double the 8.6% of sales in 2007.
- We Believe WD-40 Has Few, If Any, Growth Avenues Left and Distribution Channels Look Full: As a 65+ year old company relying on a core lubricant product, it's easy to understand that finding new markets and introducing new and successful products can be challenging. We observe that WD-40 is taking actions consistent with a mature company, including investing less and less in R&D every year, and covering-up disclosures about challenged products and ventures. At the same time, WD-40 continues touting geographic expansion with a $1bn market opportunity. A year ago, it even listed Venezuela and Iran as market opportunities for its products. By far, WD-40 has been promoting its ambitions in China, once claiming sales would be $100m. Yet, 17 years ago it admitted that 25% of the market was counterfeits. We find evidence that counterfeits continue to plague its growth ambitions there. Asia-Pacific and China have recently become an extreme weak spot for the Company, and while it blames the issue on "formulation changes" and China holidays, we suspect there are more structural issues that will hamper its ability to reach its lofty Chinese goals.
Recent channel checks and company disclosures indicate greater promotion and channel incentives. Our channel checks show some retailers offering their own store brands, like WalMart, and in some cases offering competing products up to 60% lower in price than WD-40's comparable product. In the home improvement and auto center market, we find that PB Blaster is becoming a formidable competitor, driving more intense price promotion. WD-40's Days Inventory Outstanding and Cash Conversion Cycle are materially higher than the past cycle.
- Covered by Just Two Bullish Analysts, No One Has Explored the Downside Case Until Now: Despite a $2.7 billion market cap, WD-40 is largely under-followed by the sell-side brokerage community. Instead, it appears the CEO has sought endorsement from retail investors through channels such as CNBC's Mad Money. The analysts push the Company narrative that WD-40 is recession resistant, yet don't point out that during the last crisis WD-40 wildly missed its targets and experienced declining sales and EPS. We believe this time around, the magnitude of the miss will be greater.
Sell-side analysts also point to the recent plunge in oil as a catalyst to buy the stock. While we acknowledge that 33% of WD-40's cost to produce a can is petroleum-based specialty chemicals, this benefit comes at the same time as severely depressed economic activity also affects sales. In addition, WD-40's competitors (already pricing products below WD-40) get the same benefit and can become even more price aggressive to take share. Currently trading at 6x and 27x 2020E consensus sales and EBITDA, WD-40 is priced beyond perfection. Once investors come to grips with the reality that WD-40 will repeatedly miss aggressive forecasts set by management, and reiterated by analysts, we believe its multiple will compress to more realistic levels in-line with low/no growth consumer product and specialty chemical peers. At a generous 2x and 12x sales and EBITDA multiple on our lower financial forecasts we estimate 55% – 60% downside risk.
Spruce Point Capital has a short position in WD-40 (NASDAQ: WDFC) and stands to benefit if its share price falls.
About Spruce Point Capital
Spruce Point Capital Management, LLC is a forensic fundamentally-oriented investment manager that focuses on short-selling, value, and special situation investment opportunities.
Spruce Point Capital Management
Spruce Point Capital Management, LLC is a member of the Financial Industry Regulatory Authority, CRD number 288248.
SOURCE Spruce Point Capital Management, LLC