Source: Trex.
Engineered outdoor decking maker Trex Co. (TREX -1.08%) followed up its strong bounce-back second quarter with an even better third quarter. Not only did the company beat its own revenue guidance of $92 million by $3.5 million, but it also beat Wall Street analyst estimates for revenue and earnings per share. Net sales were up 32% in the quarter, and EPS of $0.28 brings the total so far in 2014 to $1.10 -- almost double its $0.56 through the same period in 2013.
The company has managed to deliver these strong results even as the home remodeling industry has lagged, as reflected by the poor results from peers like Lumber Liquidators and Tile Shop Holdings so far in 2014. The thing is, even with a record-setting year in the making, Trex looks to be positioning itself for years of strong growth. Let's take a look at three key takeaways from the earnings release and conference call.
1. Blowout Q3, moderated projections for Q4, but it's the long term that matters
It's important to note that the company is "only" guiding for about 10% growth next quarter. The fourth quarter will mark a full year's results with its current distribution lineup, which was expanded significantly at the end of the third quarter last year, leading to 38% sales growth as the new distributors began stocking up for the spring building season.
Furthermore, the company is projecting for about 13% sales growth for the full year, to a record $388 million in total sales. This growth marks another year of low double-digit sales growth that is largely the product of market share gains, as the market for high-ticket home renovation projects remains muted. While revenue growth has been strong, Trex may not produce the same level of EPS as 2013's $2.02, but this isn't really a "bad" thing, as the company's tax basis last year was essentially zero, versus a $38% tax rate in 2014.
Trex is a seasonal business, with the building season starting in the spring, and historically running through June before beginning to slow over the summer. The fourth quarter is historically the slowest period. Furthermore, the company will only give quarterly guidance going forward, after making an exception last year due to the significantly expanded distribution partnerships entered in Q4.
Nonetheless, the fact is that all of the growth this year has been in a very poor environment. Once the market rebounds and people start spending on these large-ticket projects, Trex will be well positioned.
2. Poly pellet business: California bag ban "not an impact"
Plastic bags make up a small fraction of Trex's inputs, which are mostly recycled film wrap.
The new product that Trex has entered into -- polyethylene pellets for poly film manufacturers -- has yet to "move the needle" according to CEO Ron Kaplan, but that's fine because it wasn't expected to be a contributor this year. On the earnings call, Kaplan said that the initial product is being produced and sold as anticipated, and that the installation of the first four lines that will produce at volume is on schedule for early 2015. He reiterated that they will slowly ramp up production, and that full production in the second half of the year would have a material impact on results.
One analyst asked Kaplan what the potential impact of California's decision to ban plastic grocery bags would be on its costs. Kaplan said that, while these are what the public sees, it's actually a very small part of the company's input mix, in the "mid-single digits" on a percentage basis, with poly wrap material being their primary input source. Furthermore, he said that they were not expecting that this ban would cause their pricing to increase, either.
Management is projecting $50 million to $80 million in annual sales from this new business by 2017, with relatively smooth growth each year, meaning that it's reasonable to project this business adding about $10 million to $20 million in sales next year, almost all in the second half of the year.
Additionally, the benefit of this business to Trex is twofold. Not only is it a new source of revenue and income, but it will help Trex to better utilize its facilities and labor. Because of the seasonal nature of the outdoor decking business, having year-round demand for at least part of its product will soften some of the lumpiness in its business, while also increasing utilization rates. Kaplan also made it clear that the first two rounds of expansion -- with the first one to be completed in 2015 and the second one in 2016 or 2017 -- will not require additional real estate, but will be able to use existing space in its current manufacturing facilities.
3. Cost reductions, share buybacks
On the earnings call, Kaplan said that the "strategic initiatives" that the company had undertaken to improve efficiency and reduce costs had essentially been completed, and that the full impact of these on margins and lower costs would be reflected in the fourth quarter's results. While specifics were not provided, the message given last quarter was that these were almost all process-improvement based, and not capital investments.
Also, the company's sales, general, and administrative expenses did go up this quarter in real terms, but they declined as a percentage of sales to just over 17%, from closer to 20% last year. This is a product of both increased utilization and the efficiency initiatives.
The company also reinitiated a share buyback program, after completing its prior $50 million buyback program in the first half of the year. The new program gives approval to repurchase up to 2 million shares, which would equate to about $77 million based on recent share prices. Since the third quarter of 2013, the company has spent $75 million in share buybacks:
TREX Shares Outstanding data by YCharts.
Another 2 million shares repurchased would reduce shares outstanding by another 6.6%. Management has -- so far -- demonstrated it can effectively repurchase shares without hindering the company's ability to expand its business. Considering that the repurchases are not paid for with debt, and that the company is doing them while the remodeling market remains muted, they will very likely pay big returns to investors who hold their shares through this slow period.
Looking ahead: Strongest player in a market set to rebound
While it's not clear when the housing market will recover or when homeowners will resume spending for big-ticket projects like a Trex deck, what is rather plain is how well the company has positioned itself for that inevitable rebound. Trex has managed to grow in a flat market by taking market share from the competition, and this expanded distribution stands to really pay off when the market does recover.
Whether that happens in 2015 or later is uncertain, but that's out of the company's control. Management is focusing on things that it can control, however, like the share repurchase program, which has been successful so far, and the expansion into a new market that is unrelated to the core business but leverages what Trex is good at.
