Trex – Time To Take A Bite (NYSE:TREX)

At a time when the market is recovering from the largest concerns related to the war in Ukraine, some names are appearing on the 52-week low list, one of which includes Trex (NYSE:TREX). This is interesting enough as the move comes after a strong 2021, both on the operational and share price front.

An Update – An Overview

Trex is a play on outdoor living, providing beautiful decks for the outdoor space across a variety of composite materials which are set to replace wood with superior price, quality and sustainability attributes. Other benefits include no rotting, no splinters, no painting, no staining, no fading of color and no fertile ground for termites, among others. Besides decks, the company provides related products such as railing, outdoor kitchens and cladding as well. Of course, the solution comes at a higher upfront price compared to traditional wood, but the lifetime value of such a solution makes Trex very competitive, with far lower to no maintenance costs incurred with a Trex solution.

The very nature of these activities makes that the business has seen a huge tailwind in the wake of the pandemic, with consumers not being able to spend on other services or holidays, as they en masse remodeled their homes, gardens and alike. The company offers these solutions to consumers at nearly 7,000 distribution locations which includes giants like Home Depot (HD) and Lowe’s (LOW), contractors, builders, and other distributors.

The company has seen solid operating performance in recent years, as it is important to note that this was already seen ahead of the pandemic. Just a half a billion business in 2016, the company grew to three quarters of a billion in revenues in 2019, after which sales rose spectacularly to $881 million in 2020 amidst the pandemic. Revenues rose sharply to $1.2 billion in 2021, as the pent-up demand from the pandemic was really only seen in the year after the outbreak of the pandemic. In the meantime, EBITDA margins have been stable and steady at nearly 30%, with operating income coming just a few points below that.

The spectacular operating performance has translated into handsome returns for investors as well. Just a $10 stock in 2016, shares traded at $50 ahead of the pandemic as shares rallied to the $100 mark last year, to peak at $140 in December. Ever since, we have seen a violent move in the form of a 50% pullback to current levels of around $65 per share.

What Now?

In February 2021 the company posted its 2020 results with revenues up 18% to $881 million. The company posted adjusted earnings of $180 million, or $1.55 per share for the year. Needless to say, that valuation was very high with shares trading around the $90 mark at the time, even as the company held a dollar in net cash on its balance sheet, as the company and investors were looking for further growth.

Momentum was very strong during the year with revenue growth only accelerating from 23% in the first quarter, to 41% in the second quarter and even 45% in the third quarter. To manage and fulfil this demand, the company announced a major capacity expansion, with the company spending $400 million on a new production facility in Arkansas, with the project expected to last from 2022 to 2024. Rapid growth resulted in a boom in earnings as well, with earnings already totaling $1.59 per share in the first three quarters of the year alone.

Even with earnings comfortably running above the $2 per share mark, a valuation at a peak of $140 was very hard to justify, translating into sky-high valuation multiples. In February, it became apparent that fourth quarter revenue growth slowed down to 33%, as full year sales were up 36% to $1.2 billion as adjusted earnings per share were up a similar 36% to $2.10 per share, as net cash was reported at $141 million.

For 2022 the company expects some kind of normalization with double-digit revenue growth seen, and EBITDA margins pegged at 30-35%. Free cash flow is likely an issue as capital spending is seen above the $200 million mark, earmarked for capacity expansion, while depreciation now trends at just $40 million per annum. Nonetheless, that is no major issue given the profitability and state of the balance sheet.

Fair to say is that earnings likely come in around $2.50 per share based on the outlook, but the volatile environment casts real doubts on this, as spending on this category and other pandemic plays is set to fall back amidst economic uncertainty, inflation and tough comparables.

Concluding Thoughts

The reversal by more than 50% in just four months’ time has been violent, the truth is that the valuation at the start (that is late in 2021) was too high from the get go. Hence, valuation multiples have compressed, yet at $65 the company still trades at 26 times earnings if they come in at $2.50 per share, or 32 times if earnings are stable around $2 per share. Needless to say that these are high valuations, but a lot more justifiable than late in 2021 as this is a secular growth story.

Given all of this I am getting a lot more upbeat on Trex here as I am a believer in the secular (international) growth story. While the valuation is still high and inflationary and interest concerns weigh on consumer spending and the housing market, Trex is likely a long-term secular winner here.

Hence, current valuations start to look compelling after a very fierce pullback, which makes that I am slowly starting to initiate a position here, based on the long-term investment case/argument, applicable here.