(28) 'Records of Value Investing': Case Study of a Business with an Economic Moat — Growth Value Analysis of WD-40 (Part 1)

After appropriate adjustments in 1994 for excessive depreciation and one-time expenses, average annual net profit stood at $21 million. ・ The scale of net cash remained essentially unchanged; thus, the 86% dividend payout ratio was fully funded by earnings and sustainable. ・ Accordingly, the cash-on-cash return calculates to approximately 5.7% × 86%, i.e., 5%. ・ (2) Returns from Growth ・ Organic growth return: Revenue and profit growth driven organically by WD-40’s existing product lines, distribution arrangements, and productivity improvements. ・ First examine WD-40’s nominal revenue and inflation data, then compute real revenue. ・ Focus on the fundamental drivers of WD-40’s revenue growth: ・ (1) Rapid export growth into emerging economies—thus unbounded by slower growth in developed economies such as Europe and North America. ・ (2) WD-40 appeals across all household income levels and is therefore unaffected by rising income inequality. ・ (3) WD-40 is a product—not a service—and thus is not subject to the global consumer shift from goods to services. ・ Synthesizing these factors, future demand growth for WD-40 is expected to slightly lag global GDP growth. Global GDP growth post-1998 is projected at 5% annually (1.5% population growth + 3.5% global productivity growth); WD-40’s real growth rate is thus estimated at 4%. ・ With global inflation remaining around 1.5%, nominal GDP growth stands at ~6–6.5% annually—implying a maximum nominal demand growth for WD-40 of ~4.5%. ・ Assuming a modest, permanent decline in margins prior to 1998, a 4% organic growth rate is reasonable. ・ WD-40’s organic growth investment composition: working capital ・ WD-40 outsources all manufacturing and distribution. ・ Accounts receivable and inventory represent 20% of sales, partially offset by accounts payable and accrued liabilities equal to 6% of sales. ・ Thus, each additional $1 of sales requires $0.14 of incremental net working capital. ・ In 1998, sales totaled $144 million; at a 4.5% growth rate, sales increased by $6.5 million, requiring ~$1 million ($6.5 million × 14%) in additional net working capital—equivalent to 4.5% of the $21 million in sustainable profit for 1998. ・ If 86% of earnings continue to be distributed to shareholders, and 4.5% supports organic growth, roughly 10% of earnings remains available for active reinvestment. ・ In summary: 5% cash return, plus 4% annual value growth from organic growth, totaling 9%, while retaining ~10% of earnings for value creation via active reinvestment. ・ Return on active reinvestment: return generated by actively managed reinvestment programs. ・ Amount allocated to active reinvestment: ・ Per the above analysis, after allocating $19 million (86% of $22 million) to shareholders and using $1 million to support organic growth, the remaining $2 million of sustainable earnings is earmarked for active reinvestment.

(30) 'Records of Value Investing': Case Study of a Business with an Economic Moat — Retrospective Review of the WD-40 Investment

(Long-term sustainability is questionable), so assuming a 20% tax rate is appropriate for estimation purposes. ・ Estimated 2018 profitability: $62 million ($409 million × 19% × 80% post-tax) ・ Assumed earnings are either distributed to shareholders or deployed in active reinvestment (net of the portion required for organic growth); active reinvestment earns a return equal to WD-40’s cost of capital. ・ Organic growth: ・ Aligned with broader macroeconomic trends: as growth slows in both developed and developing economies globally, organic growth has declined from 4% annually to 3%. ・ At a 3% organic growth rate, WD-40’s sales growth amounts to $12.3 million annually ($409 million × 3%). ・ Since each additional $1 of revenue consistently requires $0.15 of net investment, $2 million of retained earnings is needed to fund organic growth. ・ Thus, the remaining $60 million of sustainable earnings is distributable to investors. ・ As of end-September 2018, the acquisition cost of WD-40’s core business comprised $2.392 billion in equity ($172.10 × 13.9 million shares) plus $37 million in net debt, yielding a total enterprise value of $2.429 billion. ・ The $60 million in sustainable annual distributions to shareholders equates to a 2.5% cash-on-cash return ($60 million ÷ $2.429 billion). ・ Total return = 3% organic growth return + 2.5% cash return (active reinvestment returns are negligible and thus omitted).

WD-40 Company (NASDAQ:WDFC) Stock Has Consensus Price Target of $305.00

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Analysts assign a $305 price target to WD-40 Company following strong Q2 earnings, with EPS of $2.33 beating estimates and revenue growing 24.3% year over year.

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