Quick update of WDFC, doubt I do this often, but they reported so soon after I wrote on it I thought I’d give some thoughts. We’re seeing the green shoots of recovery on margins, but EMEA was weak, much more than expected. All in all, nothing changed in my thesis, but I’ll expand.
Maintenance sales (their core product) declined about 30% in EMEA. That’s stark for a business that was resilient in 2008. It would have been just 15% FX-neutral and they did exit some Russian and Belarus business, but still. It was only down 1% in the Q ended Aug. They sell through distributors in the EU, so no surprise in the face of uncertainty, distributors are destocking.
As such, EBITDA missed my estimate by about $5MM ($23MM vs. $28MM) solely due to this. GMs even beat my estimate by about 50bps. And mgmt basically said they have no change to their expectations, which is a second-half story. Normally I take the under on any second-half story, but this one makes complete sense.
I reviewed the “cost of a can” to see what is really driving the margin erosion. Basically 65% of a WD-40 can is either related to oil or tin. While packaging doubled in $s, the real needle movers are the chemical inputs, can, and manufacturing fees. These manufacturing fees are essentially warehousing and freight costs.
I think all of these will be tailwinds in second half.
Plus, China sales grew 22% on the maintenance side and 32.5% in APAC-ex China. So that is a good sign and probably more room to run as China re-opens.
Outside of that, last thing I’ll highlight is they have way too much inventory. They should destock themselves. But anyway, I expect that’ll be a 2H cash source. Could be up to $85MM, honestly. That may seem small, but it ain’t nothing for a company I expect to recover to $120MM+ EBITDA plus have a cash release like that.
ABM reported a fine Q3’21 – EBITDA increased 20% on a 14% increase in sales and was slightly ahead of expectations. However, the stock is down about 10% since reporting and was down >15% at one point.
Must be a terrible outlook, right?
Well, their EPS guide at midpoint was around consensus BUT only if you exclude costs related to their ELEVATE investment program. Otherwise EPS would be $2.67 at mid-point vs. $3.43.
ELEVATE expenses will be $72MM next year and between $150-$175MM over the next 4 years. About half of the ELEVATE spend will be digital transformation costs, 20% for growth and the rest for workforce and people capabilities.
But that investment seems well worth it.
In return, the company expects margins to exceed 7% (from 4% back in 2017 and 5% in 2019. High margin COVID clean-up work led margins to be 6-7% in 2020-21 which no one believes is sustainable).
So think better price optimization, better sales targeting across business lines, better software. Also more capable / productive labor management, which will be needed in a tight labor market.
In addition, mgmt expects to acquire another $900MM in revenue (total of $2BN including the recent Able acquisition). That means 2025 revenue will exceed $9BN and EBITDA should exceed $630MM (from $375MM at end of 2020).
All in all, I’m a long-term investor and the company is investing for the long-term. I get the disappointment – maybe on some level this is an admission that the company has some real expenses to be competitive. At the same time, it’s not like expenses have to go up for revenue and EBITDA to be flat (that’s a real issue).
In my prior posts, I’ve noted how ABM is a compounder no one really talks about – they take cash flow from the main business and expand into others or grow their core. The company has solid exposure to warehousing, which will clearly be growing rapidly over the next 5 years with Amazon and Shopify.
As an aside, they discussed getting into more technical positions. Frankly, I know one business called Therma which does HVAC services, but for high-tech areas like labs and semiconductor fabs where HVAC truly is mission critical and limited providers can do it. I’d leap if they got this thing (currently owned by PE). Not really in their current wheelhouse, but not too far of a stretch either.
At the same time, ABM continues to look very cheap.
Here’s the company’s reasoning for the results and it is obvious:
Sales to Stellantis / Fiat Chrysler Automobiles (FCA) and General Motors Company in the current year quarter decreased over the same period in the prior year quarter due primarily to lower vehicle production volumes for which we supply components due to the continuing impact of the global semiconductor chip shortage. Sales to the Ford Motor Company in the current quarter increased primarily due to the increased content on the F-150 pick-up truck for which we supply components. Tier 1 Customers and Commercial and Other OEM Customers were down in the current year quarter compared to the prior year quarter due to lower production vehicle volumes relating to the semiconductor chip shortage referenced above
Short-term, results will be ugly!Long-term, this bodes well for an elongated up cycle.
The reason why used car prices continue to make new highs is simply because people can’t get new cars. As new cars are continuously delayed, the existing fleet will continue to age, resulting in a large restocking cycle down the road of new cars. It isn’t that people don’t want cars – it is that they can’t get them. I’d much rather have that alternative than the latter.
Case in point, check out Lithia Motors inventory numbers lately and look how limited new vehicle inventory is (and used for that matter). They typically have 77 days supply of new cars, but instead now just have 24 days!
Long-run, I still think Strattec stock is going for <3.5x normalized EBITDA, which is not too bad!
I last did a “don’t miss the forest for the trees” post on Big Lots. That company went on to rally from when I posted it (not because of me, but because the reaction was way too negative). Unfortunately, supply chain concerns have created new pressures on BIG. In a similar vein, supply concerns are now pressuring LGIH stock, but I remain unfazed and take comfort in the long-term story.
LGIH just posted September home closings were 793 vs. 811 last year, which is a miss for a company “growth” company and I believe this is below expectations. They didn’t report earnings, but investors closely watch these reports for signals of how the quarter will shape up.
We’ve seen other builders also lower their guidance already:
Pulte (PHM) lowered closings 6%
DR Horton (DHI) lowered closings 9%, but raised GM target, so net / net EPS impact was margins
Lennar (LEN) lowered closings 5%
KB Homes missed closings by 7%
Hovnanian just lowered guidance for closings and lowered EBITDA expectations (see yellow line below).
So clearly the homebuilders are all aligned here.
But you need to understand why they are all guiding down: tight supply. To me, this firms the thesis.
LGIH is a largely spec builder at really attractive price points. While they are selling lots very quickly and now need to reinvest, I am comfortable that this model will continue to do very well in the long run. Absorptions are still running at 7.7 (compared to average pace of 6.5) so again, this isn’t really a demand issue, but more so a supply problem. I like it when demand outstrips supply.
Interest rates have also increased modestly, so can’t help but think that is pressuring the stock. That could have a severe impact on the price, but again, I’d likely be unfazed given the long-run story here.
At ~8x forward PE and 2x TBV, I also think valuation is undemanding (DHI trades at 1.6x TBV).
This update will be brief, but I wanted to highlight that ABM recently reported last week, following its M&A announcement that I covered in this note.
When I first wrote about ABM stock, I said (i) guidance was way too low, and I expect a lift in guidance across the board (ii) there’s upside optionality from doing a large acquisition and (iii) the stock is cheap.
If you had told me that ABM would go on to raise EPS guidance TWICE and announce an $830MM accretive-day-one deal, yet ABM stock would be little changed, I’d be SHOCKED. The stock is actually down about 6% since I wrote about it…
When ABM reported, they increased EPS guide now to $3.5 at mid-point. This is now at the high range of the previously stated EPS guide.
Not to brag, but this is exactly where I thought it should be, which you can see in the original table I posted:
Why the Muted Reaction?
I struggle to believe this was “priced in” to ABM stock when I first wrote about it, I just think sustainability of earnings is being questioned. However, management actually noted the current high margin environment will likely persist for even longer than I thought:
Overall, demand for ABM’s higher-margin virus protection services remained elevated in the quarter, underscoring ongoing client concerns regarding cleaning and disinfection of their facilities. As anticipated, demand for virus protection eased slightly in the third quarter compared to the second quarter of fiscal 2021, but remained well above pre-pandemic levels. The emergence of the Delta variant and rising COVID-19 cases nationally have gained heightened interest in the need for disinfection prevention measures, particularly in high-traffic areas. As we look forward to 2022 and beyond, we believe that virus protection services will remain a contributor to our overall revenue as disinfection becomes a standard service protocol in facility maintenance programs
….So I think it’s still hard for us to pin down a formal long-term margin. We’re looking forward to giving you full year guidance in the next 3 months, and then that will give you the insight for the next year. But look, we’re going to say what we’ve continued to say throughout, which is the 2 areas for elevated margins are in disinfecting and labor arbitrage. And we believe we will permanently keep portions of that. As we restaff these buildings, we believe we’re going to be able to do it more efficiently, and we’ll capture some savings. Again, it’s still too early to figure out how much.
And then the disinfecting, we see like maybe 2 quarters ago, there was — or maybe even a quarter ago, there was no Delta variant, right? So like I think this is going to continue to evolve. And we’ve all just said it even anecdotally. It’s just… I don’t think facility managers or landlords or principals of schools, I don’t think anyone thinks it’s responsible to discontinue disinfection services, especially in high-touch areas. So that’s going to continue, too. So we believe we will continue to be elevated, but give us until next quarter when we do full year guidance to kind of give you that year outlook.
So again, I go back to the original pitch. I’m not necessarily expecting this work to last forever, but here’s what ABM will do (and basically already did):
they’ll generate a ton of FCF (about 11% of market cap by my math)
they will use cash first to pay down debt from the Able acquisition
Once they are in a comfortable range, they’ll buy something else
Rinse & Repeat
This is what compounders do, it’s just a bit frustrating when this compounder gets no love.
I think the pushback is that margins likely will go down in the future – but what does it matter if earnings DOLLARS are higher? (They buy something else, there are some structural changes in the business, aviation and education segments are roaring back at higher margins which is happening, etc.)
The point of this slide to me is not that ABM is some dividend stock, but that it does a pretty good job compounding earnings.