Trex stock: finally at an attractive price after years of overvaluation (NYSE: TREX)

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We are pleased to announce that the shares of Trex (NYSE: TREX) are back at a reasonable valuation, after a few years of trading at “exorbitant” multiples. We were a bit early in giving the stocks a “Sell” rating, as they were priced around $100 and rose near $150, but have since come down to earth and are now trading near $50.

Trex WideAlpha Blanket

Looking for Alpha

It’s a company we really like because of its strong growth and strong environmental credentials. As a reminder, Trex manufactures decking composed mainly of a mixture of recovered wood fibers and a recycled polyethylene film. The company is one of the largest polyethylene film recyclers in North America, recycling waste into higher value products. It views wood as its biggest competitor, and every 1% market share it takes away from wood products translates into annual composite sales of about $80 million. There is still a long avenue for growth to take market share from wood, given that composite has a market share of around 25% compared to around 75% for wood.

Although the product is sold at a higher price than wood, sometimes even at a price 5 times higher, customers have good reasons to prefer Trex products. One is for environmental reasons, the other is that Trex has a lower cost of life, given that it is expensive to continue to maintain outdoor wood products. The average ROI to go with Trex is only about 3 years, and customers end up saving thousands of dollars on average.

Economy of Trex products

Presentation to Trex Investors

finance

Trex is no longer the company it was a decade ago, when it had significant cyclicality in its profit margins. Its earnings volatility has declined and its margins remain quite high, in particular it has demonstrated strong operating leverage, and its operating margins have benefited. Its latest operating margin was a very attractive 27.9%.

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Data by YCharts

Trex has also provided a very high return on investment, recently posting a 32.22% return on invested capital. This shows how attractive a company Trex has become, and its return on investment has not been less than 20% since 2014.

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Data by YCharts

Overall, Trex delivered superior financial performance, with EBITDA growth of approximately 20% and sales of approximately 18%.

Trex Long-Term Financial Results

Presentation to Trex Investors

Balance sheet

Trex has a very strong balance sheet with virtually no long-term debt and approximately $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 in its share buybacks.

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Market

One explanation for the decline in the stock price is concern that higher interest rates to fight inflation will have the effect of slowing residential construction in the United States. Although some slowdown should be expected due to rising rates, so far residential construction remains incredibly strong, as seen below.

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Data by YCharts

In addition, Trex benefits not only from new construction, but also from renovations. Outdoor living remains a major home improvement market segment. In fact, exterior property improvements account for about 38% of home improvement spending and are the fastest growing segment. And thanks to the market share gains compared to wood that Trex has made, its sales are growing much faster compared to the renovation market.

Trex Growth

Presentation to Trex Investors

Growth

Over the past ten years, Trex’s revenue growth has averaged around 17%, but growth has been much stronger recently, even reaching over 40% a few quarters ago. While a slowdown in home construction and renovation would certainly impact these growth rates, we would be surprised if it got to the point of making sales growth negative for an extended period. Over the past ten years, growth has only dipped below 0% a few times, and growth tends to pick up fairly quickly.

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ESG

There is a long list of environmental footprint improvements over wood from Trex products, which is illustrated in the slide below. Benefits range from reduced greenhouse gas emissions to air pollutants, fossil fuel use, smog emissions, water use, and more.

Trex ESG

Presentation to Trex Investors

Orientation 2022

Despite market fear of a slowdown in home construction and renovation, Trex forecasts strong double-digit revenue growth for fiscal 2022. This further reinforces our belief that stocks have become quite attractive at current prices. .

Trex Tips 2022

Presentation to Trex Investors

Evaluation

Looking at some valuation multiples, we can see that stocks haven’t been as cheap as they are now 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 buybacks, which it tends to increase when it believes its shares are undervalued.

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Data by YCharts

The price/earnings ratio is also becoming quite attractive, especially the forward price/earnings ratio, as analysts expect earnings to continue to rise.

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Data by YCharts

Risks

Apart from a slowdown in residential construction and renovation spending, we see no short/medium term risk to the company. Its balance sheet is incredibly strong, with an impressive Altman Z score and clean cash. Longer term, we see a risk of another company developing an even better composite material than Trex, but we believe this is a low probability risk.

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Data by YCharts

The number of shares sold short has increased, but remains well below previous highs in the percentage of outstanding shares sold short. We believe the reason there is an increase in stocks being sold short is that some investors are using the company as a vehicle to bet or hedge against a slowdown in home construction and renovation.

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Data by YCharts

Conclusion

We are surprised at how quickly Trex shares have gone from overvalued to undervalued. This is an excellent business that we believe can continue to grow at a rapid pace, even if temporarily slowed by a slowdown in residential construction and renovation spending. The company seems to agree that its shares are undervalued, given that it is ramping up share buybacks. After waiting a long time for a good entry price, we may soon be buying stocks.

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