Trex Company Inc (NYSE:TREX) reported financial results for its fourth quarter and fiscal year 2016 on Feb. 21, delivering another quarter of steady revenue growth, and very strong profits. Sales increased 7% in the quarter to $95 million and 9% to $480 million for the full year. Net income was up 56% to $12.6 million and 41% to $68 million for the quarter and year, respectively. Factor in share repurchases over the past year, and earnings per share increased 65% in the fourth quarter and and 51% in the full year. 

And while there are a number of factors that helped drive incremental earnings growth in 2016 that won't give the same boost in 2017, management is expecting profits will still grow faster than sales as efficiency and cost-containment initiatives play out, and even modest sales growth drives operating leverage and gross margins higher.

Family sharing a meal on their deck.

Image source: Getty Images.

Let's take a closer look at Trex's results, what management had to say, and some key investor takeaways. 

A closer look at revenue, profits, and a few key breakout points

If there was one potentially concerning number from Trex's fourth quarter, it was 7% -- the revenue growth result the company delivered. While far from being a bad result, it was one of the company's slowest sales growth periods in the past couple of years. This is where some added context on the results is important. 

On the earnings call, CFO Bryan Fairbanks said the company took a $1.3 million charge against both revenue and gross profit in the fourth quarter. And while both he and CEO Jim Cline refused to offer much in the way of detail for competitive reasons, they both made it clear that this was an investment in growing future sales.

Factor that investment back into the reported results, and sales would have grown 8.5% in the quarter, more in line with full-year revenue growth, and boosting gross margin even more. The key point? Management continues investing in growing the business, even when it means short-term charges. 

Another big change to Trex's operations impacted sales by $7.6 million in 2016. In the past, the company has purchased far more used poly than it needed, selling the rest on the secondary market. In 2016, the company ended this practice, buying far less poly at the cost of not being able to sell the leftover material. Trex sold $7.6 million less excess poly in 2016 than the year before, but since this wasn't a profit-centric action, the loss of this revenue didn't have a negative impact on profits. To the contrary: Revising this process more likely has boosted gross margin, while also freeing up more operational resources to devote to the core business. 

Combined, the fourth-quarter charge and changes to the poly buy/sell program meant nearly $9 million in "lost" revenue in 2016. The bigger lesson is that one drove better operating efficiency, and the other is intended to drive future sales growth. 

Operating leverage continues to pay off with incremental profit growth

As noted above, Trex's earnings grew at a much higher pace than sales in 2016. On the earnings call, Fairbanks said that two key things drove these gains:

  • Lower raw material costs and other cost-saving initiatives.
  • Higher capacity utilization and other operating efficiency gains. 

Fairbanks said the gains were split about evenly between the raw materials savings and improved operating metrics, and pointed out that raw materials costs aren't likely to fall much farther from here, but that management feels certain they will continue to see margin gains from higher operating leverage and its operating improvement initiatives. 

This is evident in the company's guidance for 2017. After 40% gross margin in the fourth quarter and 39% for the full-year 2016, management is expecting further benefits from even modest sales growth. First-quarter sales are forecast to increase 9% (with the usual caveat about extreme winter weather potentially pushing sales into early Q2), with incremental gross margin -- that is, gross margin on incremental revenue -- of 45% to 50%.

Looking ahead

Trex is heading into 2017 with solid momentum after a successful 2016, and management is committed to continue wringing incremental profit growth from every new dollar in sales it can. But it's not just about operating efficiencies and manufacturing leverage. The company has also continued to invest in marketing, with its sights set squarely on taking more share away from traditional wood decking, and not just its wood-alternative competitors. 

Factor in a relatively strong economy and housing market, and 2017 looks set to be another solid year for the company. Eventually housing will soften, and there will be a dry patch in the economy and Trex's growth may stall for a short period. But looking at the long term, Trex has a very big opportunity to grow its market share for years to come.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.