A key part of Trex Company, Inc.'s (NYSE:TREX) marketing strategy for the past several years has been distinguishing itself from its competitors in the wood-alternative decking business. And that strategy has worked wonders, with Trex increasing its market share from below 30% in 2008 to more than 40% in the most recent data available. That marketing focus, along with a high-quality, differentiated product, has helped drive Trex's revenue and profits upwards consistently. But starting this spring, Trex is targeting a much bigger market in its marketing: old-school wood.
And following Trex's earnings report for its second quarter on Aug. 1, it's looking like that strategy is paying off, with the company reporting strong revenue and profit growth. Will Trex's strategy to target wood decking and not its competition continue paying off? Let's take a closer look at the company's results in the quarter, as well as what management says going forward.
A look at how Trex is driving its profits higher
|Metric||Q2 2016||Q2 2015||Change|
|Earnings per share||$0.79||$0.58||36.2%|
|Gross margin percent||41.9%||38.4%||350 basis points|
As you can see above, Trex's profits shot up 25% on a relatively modest 7% revenue increase, while earnings per share increased even more after a timely stock buyback earlier this year. The biggest driver behind this strong profit growth? Operating leverage.
Over the past year-plus, Trex management has been working hard to improve its operating efficiency and drive down unnecessary costs, and in the first two quarters of 2016 the results have been apparent. In the first six months of 2016, net sales are up 8%, while sales costs are only up 1.5%. Partly responsible are lower feedstocks, as recycled polyethylene prices are down, but by and large the company has simply improved its cost structure and manufacturing processes.
It's also worth noting that sales, general, & administrative expenses increased 10.3% in the quarter, a higher rate than revenue, but this was intentional, as management deferred some of its marketing spending in the first quarter into Q2. Year to date, SG&A expense is up 5.4%, and as a percentage of sales it has actually fallen through the first half of 2016 versus last year.
Going after a bigger market
As noted above, Trex has made steady gains in market share for years and now commands well over 40% of wood-alternative decking sales. But as the company emphasized in its investor presentation back in May, its peers in the fake wood industry aren't really the competition.
If we do a little math, it's pretty easy to see why Trex wants a piece of the pie that traditional wood still commands. Based on the data above and Trex's 41% market share of wood alternatives, that gives Trex roughly 7% market share in total decking sales. And that's why Trex is targeting wood in its latest marketing campaign, as the next phase in its efforts to build on its strong brand recognition and industry-leading distribution network. Here's another slide from the company's investor presentation:
In other words, Trex is counting on its strong brand recognition and effective social media marketing to aid in its latest marketing campaign. Most importantly, there's simply massive opportunity for Trex to continue growing -- far beyond simply taking more market share from its alt-wood competitors.
Trex CEO Jim Cline said that management expects 12% sales growth in the third quarter to $105 million and that the strong gross margin gains of the first half of the year should continue. He also gave his thoughts on the longer-term outlook:
Longer term, we see significant market opportunity. Trex brand recognition has never been higher, initial metrics indicate that our marketing campaigns are gaining traction with both the trade and consumers, and our innovative product line-up positions us for continued leadership in the decking and railing market supported by increased conversion from traditional wood products.
He also pointed out that each 1% share of market taken away from wood was worth about $50 million in revenue, further emphasizing how even small gains could make a big impact on Trex. But at the same time, he also emphasized that this new marketing focus was only months old at this point and would be a multi-year campaign. Furthermore, Trex continues to see accelerated international growth, though sales outside North America still make up less than 10% of revenue.
Put it all together, and there's still a lot of room for Trex to run. Now happens to be a wonderful time to do it, with a healthy housing and home improvement market that hasn't shown any sign of slowing down anytime soon. And while it eventually will go through a slowdown -- housing is cyclical, after all -- Trex is well positioned to continue growing its share of total decking sales for many years to come.
Jason Hall owns shares of Trex. The Motley Fool owns shares of and recommends Trex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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