Trex's (NYSE:TREX) fourth-quarter and full-year financial results are out, and frankly, it's another great quarter. The highlights:
- Q4 sales of $74 million, up 16% and better than company guidance and Wall Street analyst estimates
- Earnings per share up 27% for the full year.
- Free cash flow of $46 million, up 39% from the year before
- Guidance for first-quarter sales to grow 19%.
Can Trex keep growing, even as the housing and remodeling market remains relatively weak? While the company can't control the market, management can take steps to position the company for the future. Let's take a closer look at a few key points from the earnings report for details.
Moving beyond previous quality issues
When Trex CEO Ron Kaplan took over back in 2008, the company was in bad shape. Debt had ballooned, margins had steadily fallen, and there would be a series of major class action lawsuits tied to earlier products that failed to perform reliably. Today, the company carries essentially no long-term debt (though it uses a line of credit for liquidity, but pays debt off within months), regularly reports gross margins 50% better than in the past, and typically produces about double the free cash flow as in prior years. Furthermore, the company settled essentially all litigation regarding product quality more than a year ago.
Another piece of evidence that Trex has fully moved beyond any product-related overhang? The company announced yesterday that it had swept Builder magazine's brand study for 2015, placing first in all four categories it was ranked in, which cover both quality and brand recognition. This result has been driven by two key efforts: product development and a serious focus on both distributors and contractors.
Kaplan has spoken about the company's dealer and distributor network in the past, and the company's expansion of it has been the key driver of growth over the past year. With the home remodeling market having been essentially flat over the past several years, almost all of Trex's sales growth over that period has been the result of taking market share from competitors and traditional wood decking. It's a real testament to the strategy that Kaplan and his team have implemented at Trex.
Earnings down from year before, but...
Well, taxes. Earnings before taxes essentially doubled in the fourth quarter, but actual net income of $5.2 million was well below the $15.1 million in the year-ago quarter. However, the company's 2013 earnings were positively affected by a tax valuation allowance, while this year's Q4 results were based on a normal tax rate.
As mentioned earlier, free cash flow increased significantly for the year, and this is an important metric for Trex because of the "lumpy" nature of its seasonally driven business and the capital-intensive nature of being a manufacturer. Growth in free cash generation is a great sign, especially considering that the company is investing capital in expanding into the poly pellet business, which is expected to grow, but at a relatively slow and steady rate over the next few years.
Deja vu all over again on forward guidance? It probably doesn't matter
Trex management is guiding for 19% sales growth in the first quarter, a strong forecast based on comments that Kaplan has made regarding the softness of the remodeling market. Going back to last year, the company had forecast $115 million in sales in the first quarter before falling well short with actual sales of $101 million. Even worse, this was a decline from the year-ago quarter.
For those not taking notes, last winter was horrible. It lasted well into late February and March for many across the U.S., and this was exactly what Trex management pointed to as the biggest detriment to its business. After all, not many decks get built in blizzards. However, sales would rebound in the second quarter as the weather improved, leading to 23% sales growth.
While the weather impact is hard to predict, it's important to note that sales came in below management's projections for both Q1 and Q2 last year, largely because of the weather. The point? It could happen again, so don't get too caught up in this somewhat uncontrollable aspect of the company's business. What matters is the long-term execution of the strategy. And this management team has killed it in that regard.
It's important to remember that the housing market -- particularly existing home sales -- remains relatively poor. As long as this remains the case, Trex's growth will largely come from taking market share, and improvements in the company's cost structure. There is some upside in the new poly pellet business, but management has maintained that it will take deliberate and long-term steps to grow this business, and not a quick ramp-up.
However, even in a seriously changed economic and housing environment, Kaplan and his management team have rewarded long-term investors with more than 1,000% gains since taking over:
Once the housing market fully recovers, Trex is in an incredible position to benefit from it. Things might be just getting started for this best-in-class manufacturer.