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Finally At An Attractive Price After Years Of Overvaluation (NYSE:TREX) –

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Long back deck of new modern home

PC Photography/iStock via Getty Images

We are happy to report that shares of Trex (NYSE:TREX) are back at a reasonable valuation, after a couple of years trading at ‘sky high’ multiples. We were a little early assigning a ‘Sell’ rating to the shares, since they were ~$100 and went up close to $150, but have since come back down to earth, and are now trading close to $50.

Trex WideAlpha Coverage

Seeking Alpha

This is a company we appreciate very much due to its high growth and strong environmental credentials. As a reminder, Trex manufactures decking comprised primarily of a blend of reclaimed wood fibers and recycled polyethylene film. The company is one of the largest polyethylene film recyclers in North America, up-cycling waste material into higher-value products. It considers wood to be its number one competitor, and every 1% market share it takes away from wood products results in ~$80M annual composite sales. There is still a long runway for growth from taking market share from wood, given that composite has a ~25% market share versus wood’s ~75%.

While the product is sold at a premium to wood, sometimes even at a 5x premium, there are good reasons for customers to prefer Trex products. One is for environmental reasons, the other is that Trex has a lower lifetime cost, given how expensive it is to keep giving maintenance to outdoor wood products. The average payback for going with Trex is only ~3 years, and customers end up saving on average thousands of dollars.

Trex Product Economics

Trex Investor Presentation

Financials

Trex is no longer the company it was ten years ago, where it had significant cyclicality in its profit margins. Its earnings volatility has decreased, and its margins remain quite high, in particular it has shown strong operating leverage, and its operating margins have benefited. Its most recent operating margin was a very attractive 27.9%.

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Data by YCharts

Trex has also been delivering very high ROIC, posting recently a 32.22% return on invested capital. This shows how attractive of a business Trex has become, and its ROIC has not been under 20% since 2014.

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Data by YCharts

Overall Trex has delivered superior financial performance, with its EBITDA growing at ~20%, and sales at ~18%.

Trex Long-term financial results

Trex Investor Presentation

Balance Sheet

Trex has a very solid balance sheet with basically no long-term debt, and ~$115 million in cash and short-term investments. This puts the company in a strong position to reinvest in the business or be more aggressive with its share buybacks.

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Data by YCharts

Market

One of the explanations for the share price decline is fear that higher interest rates to fight inflation will have the effect of slowing down residential construction in the US. While it is to be expected that there should be some softening as a result of the higher rates, so far residential construction remains incredibly strong, as can be seen below.

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Data by YCharts

Also, Trex not only benefits from new construction, but from remodeling as well. Outdoor living remains a leading home improvement market segment. In fact, exterior property improvements captures ~38% of home improvement spending and is the fastest growing segment. And thanks to the market share gains versus wood that Trex has been making it is growing sales much faster compared to the remodeling market.

Trex Growth

Trex Investor Presentation

Growth

Over the last ten years Trex’s revenue growth has averaged ~17%, but growth has been much stronger recently, even reaching more than >40% a few quarters ago. While a residential construction and remodeling slow down would certainly impact these growth rates, we would be surprised if it was to such an extend as to make sales growth negative for a prolonged period of time. In the past ten years growth has gone below 0% just a few times, and growth tends to recover quite quickly.

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Data by YCharts

ESG

There is a long list of environmental footprint improvements versus wood that Trex products have, which is shown in the slide below. The benefits go from lower green house gas emissions, to air pollutants, fossil fuel use, smog emissions, water use, etc.

Trex ESG

Trex Investor Presentation

2022 Guidance

Despite the market’s fear for a residential construction and remodeling slow down, Trex is guiding for strong double-digit growth in revenue for FY2022. This further cements our belief that shares have become quite attractive at current prices.

Trex 2022 Guidance

Trex Investor Presentation

Valuation

Taking a look at some valuation multiples, we can see that shares have not been as cheap as they currently are since around 2016, when measured with an EV/EBITDA multiple.

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Data by YCharts

Some investors might be disappointed that the company does not pay a dividend, but it does return capital to investors through share repurchases, which it tends to ramp-up when it believes its shares to be undervalued.

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Data by YCharts

The price/earnings ratio is also getting quite attractive, in particular the forward p/e, as analysts expect earnings to continue increasing.

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Data by YCharts

Risks

Other than a softening of the residential construction and remodeling spending, we do not see any short/medium term risks for the company. Its balance sheet is incredibly strong, with an impressive Altman Z-score, and a net cash position. Longer-term we see a risk in other company developing an even better composite material than Trex’s, but we think that is a low-probability risk.

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Data by YCharts

There has been an uptick in shares sold short, but it remains significantly below previous highs in the percent of shares outstanding sold short. We believe the reason there is an uptick in shares sold short is that some investors are using the company as a vehicle to bet against, or hedge against, a residential construction and remodeling slow down.

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Data by YCharts

Conclusion

We are surprised at the speed at which shares of Trex went from being overvalued, to undervalued. This is a great company that we believe can continue to grow at a fast pace, even if it is temporarily slowed down by a softening in residential construction and remodeling spending. The company seems to agree that its shares are undervalued, given that it is ramping up share buybacks. After waiting for a good entry price for a long-time, we might be buying some shares soon.

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