Steel City Capital LP, an investment management firm, published its first quarter 2021 investor letter – a copy of which can be downloaded here. A net return of 7.6% was delivered by the fund for the Q1 of 2021, above the S&P 500 and MSCI All World Index that delivered a 5.8% and 4.8% returns respectively, but below its Russell 2000 benchmark, that had a 12.9% gain for the same period. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.
Steel City Capital, in their Q1 2021 investor letter, mentioned WD-40 Company (NASDAQ: WDFC), and shared their insights on the company. WD-40 Company is a California-based household and multi-use products manufacturer that currently has a $3.4 billion market capitalization. Since the beginning of the year, WDFC delivered a -6.38% return, while its 12-month gains are up by 47.27%. As of April 30, 2021, the stock closed at $248.74 per share.
Here is what Steel City Capital has to say about WD-40 Company in their Q1 2021 investor letter:
“WD-40’s (WDFC) most recent quarter largely confirmed what I expected to see: a deceleration of sales growth rates (following a period marked by an explosion of pent-up demand) and an inevitable compression of margins (which had been boosted by extremely favorable oil-linked input costs).
On the sales front, 2Q’21 growth decelerated to 9% y/y (FX-neutral) from 23.6% y/y (FX-neutral) in 1Q’21. Perhaps more importantly, the company’s full year sales guidance implies a further deceleration in the second half compared to the first, with 2H’21 sales growth expected to come in at 6.5%. This is particularly unappealing on two accounts.
First, the 6.5% growth is based off of a very easy comp as the comparable period in 2020 saw negative sales growth as a result of COVID. Second, the 2H’21 growth forecast now includes a sizable FX-related tailwind. Going into the print, the midpoint of sales guidance was $453 million; management increased their full-year bogey to $460 million (at the midpoint) based on favorable changes in FX rates. Excluding the new FX tailwind, the company is looking at constant currency growth of just 3.5% in the second half (again off of a very easy comp).
With respect to margins, management discussed a 200-300 bp deterioration of gross margin in the back half of the year, attributable to a mix of supply chain issues and higher input prices. While they are working to overcome a portion of the higher costs through changes to / expansion of their supply chain, management also noted that, to the extent oil prices remain at or near their current levels, margin pressure will persist.
Interestingly, the company has declined to provide formal guidance on anything other than sales, but management has also commented on every component of the income statement in response to analyst questions. In the second half we know that gross margin is going to deteriorate by 200-300 bps; Other OpEx will be 34% of sales; and the effective tax rate will rise towards 20%. Putting all of the pieces together, we can pencil out 2H’21 EPS of $2.47, which is flatto-down y/y despite 6.5% sales growth. Since that’s nothing to write home about, I suspect management just decided not to talk about it.
While shares sold off on the day following earnings, valuation remains exceptionally stretched. Full year EPS will be in the realm of $5.45, putting WDFC’s P/E at 47x. Valuation doesn’t look much different on the basis of FCF, with shares trading at ~50x normalized FCF. Looking forward to FY’22, as the world continues to normalize, I expect WDFC’s top-line growth will revert back towards historical levels in the low-single digits (GDP-like), while EPS growth will be harder to come by to the extent margin headwinds continue to prevail (and without the help of a repurchase program which the company has discontinued for the time being). There continues to be a meaningful disconnect between valuation and fundamentals. With earnings growth grinding to a halt – and potentially even inflecting into negative territory next year – I continue to expect shares will be pressured over the medium term.”
Our calculations show that WD-40 Company (NASDAQ: WDFC) does not belong in our list of the 30 Most Popular Stocks Among Hedge Funds. As of the end of the fourth quarter of 2020, WD-40 Company was in 15 hedge fund portfolios, compared to 17 funds in the third quarter. WDFC delivered a -18.29% return in the past 3 months.
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