Trex Company (NYSE:TREX) has gone from a company with bad products and big financial problems to the undisputed leader in its industry in less than a decade. The company, which makes wood alternative decking and decking accessories, has successfully grown its market share faster than the industry in recent years and just turned in a year of double-digit sales growth and 20% growth in earnings per share.
And while management continues to work on diversifying its business with a recycled poly pellets business that it has started from the ground up, the core focus remains growing the decking business.
Let's take a closer look at Trex's financial performance in 2015, as well as what the company is up to for 2016 and beyond.
|Metric||Q4 2015||Q4 2014||Change|
What happened in the quarter and year
Trex made progress in several key areas, but may be having trouble getting as traction in one growth area:
- Trex's 13% sales growth in 2015 was at least double the growth rate of the alternative decking industry, and primarily a product of increased volume, not price increases.
- Management said that prices were up about 2% last year and would be up about 1.5% in 2016.
- Trex added expanded distribution in the Southwest (including California) with Boise Cascade Company, a longtime distributor for the company.
- Sales, general, and administrative expenses, adjusted for several one-time charges taken in 2014, fell 170 basis points to 21% of sales.
- Gross margin increased to 35.1%, up 70 basis points from 2014.
- Gross margin adjusted for the $7.8 million warranty reserve (this amount is set to fall dramatically in 2016) was 36.9%, up 110 basis points.
- The specialty materials business, which makes the poly pellets, has taken longer to take off than expected, and partly because of the drop in oil prices. Virgin polyethylene is made from oil or natural gas feedstocks, and virgin pellet prices have fallen from $1.09 to $0.60 per pound over the past 13 months.This has led to thinner margins in that business, too. CFO Bryan Fairbanks said that EBITDA margins are less than half the 20% initially expected.
A look at the plan for 2016 and beyond
Much of the company's plans for this year look a lot like 2015. Management said that it would continue to focus on product development and innovation, both for its core decking business and for its poly pellets business.
The poly pellet business has been a borderline disappointment so far, but it has potential.On the call, management disclosed that it would begin selling some of the higher-value products it has been developing for key industries and customers in the second quarter and would be operating two of the four manufacturing lines in place for the pellet business. They also said that these higher-value products should attain the 20% EBITDA margins they were originally targeting.
The company is also changing its tack on marketing. CEO Jim Cline said the company was specifically aiming at showing why Trex is a superior product to the kind of wood decking sold in particular markets. He used, as an example, redwood decking on the West Coast.
The key driver behind this plan is simply addressable market size. Wood alternative decking currently has a 30% dollar share of the decking market but makes up only 16% of linear board-feet of decking sold. In other words, 84% of all the decking sold in the U.S. is regular wood. Trex is aiming at taking a greater share of that away from traditional lumber.
Share buybacks, debt, and a note on guidance
The company is also cranking up its share buyback program. In the fourth quarter, the board approved a 3.2 million share buyback program, and Cline said that it had been actively buying back shares in the first quarter. Those 3.2 million shares represent about 10% of shares outstanding, and at several points in January and February, Trex shares were down 40% from the peak in April 2015.
It's worth noting that Trex is using debt as working capital to help fund this plan. The company increased its credit line by $100 million in January. Considering that the interest rate on that revolving credit facility was 1.3% at the end of December, this isn't an unreasonable step, especially with the company's growing free cash flow, which it can use to pay down that debt relatively quickly.
Guidance for first quarter sales is $131 million, which would be 8% sales growth. However, the company is also shifting its sourcing strategy for polyethylene. The company has historically bought more than it needed and sold the excess at a slight profit, but is no longer planning to buy in so much excess. The impact on the full year will be about $10 million in lost revenue, but it won't affect profitability.
When adjusting for the lost revenue from sourcing, sales are projected to increase by 10%.
Even after rebounding 26% since mid-February, Trex shares are still off by 25% from the 2015 high. But the company -- the business itself -- has continued to execute on steady sales and market share growth. Furthermore, management continues to find ways to drive down costs, and develop new, award-winning products.
Will the company's new plans to go hard after the traditional wood deck customer will pay off? Only time will tell. But I wouldn't bet against the company.