AZEK - The AZEK Company: A Negative Bottom Line Brings Too Much Risk

2023-04-13 17:40:20 ET

Summary

• The AZEK Company Inc. is a company that hasn't been able to capitalize too much from a steadily more demanding market.
• The last report saw the company having a negative bottom line, which presents an ample amount of risk to investors.
• I don't like having too much risk in my portfolio, and a company with negative EPS is definitely a red flag to me.

Investment Summary

The AZEK Company Inc. (AZEK) is a well-established company that specializes in creating high-quality building products that elevate outdoor living spaces. Their impressive range of products includes decking, railing, trim, molding, porch, and pavers. They use a variety of materials such as wood, polymer, and composite materials to create their products. The AZEK Company is considered a top-tier provider of premium building products that consistently exceed expectations.

Even though the company is a major player in the industry, the last earnings report had some disappointing numbers. It might have come out ahead of expectations, but the bottom line was negative and that presents a major risk to investors in my opinion. I don't like having too much risk present in my portfolio. Because of that, I don't see The AZEK Company Inc. as a buy and would instead say they are better rated a sell.

Quarterly Result

In February, the AZEK Company Inc. released its earnings report for the three months that ended December 31, 2022 (its fiscal Q1 2023). The company's net sales for the quarter were $216.3 million, a decrease from the $259.7 million reported for the same period in 2021. The cost of sales was $168.7 million, slightly lower than the $171.1 million reported in the previous year, resulting in a gross profit of $47.6 million, which is significantly lower than the $88.6 million reported in the previous year. I think this highlights the company's inability to properly take advantage of the demand from the industry. One of the red flags I see from the report is the cost of sales still remaining at more or less the same level as a year before, despite revenues falling around 17%.

The quarter had the company losing $0.17 per share, and this in my opinion comes because costs remained high and revenues declined. It's a challenging time, and the losers will quickly start to fall off one by one when margins can't be kept up. The outlook by the company also doesn't seem positive:

"for full-year fiscal 2023, AZEK continues to assume an approximately 10% year-over-year decline in volume and expects Adjusted EBITDA for fiscal 2023 to be in the range between $250 to $265 million. Capital expenditures for fiscal 2023 are expected to be in the range of $70 to $80 million."

I think this highlights some of the difficulties the company will be experiencing in the coming years, and it's not something I want to be a part of.

Market Overview

In a report from datamintelligence , they outline the estimated CAGR for the global building materials market. They estimate it to be 4.76% from 2023 until 2030. I think the last report from AZEK showcased this growth might not be seen in the company's next few reports.

The management even outlined the outlook for the expected decrease in volumes, which I think is a major red flag and a sign that perhaps the competition is getting ahead of AZEK right now.

The market seems to have continued growth because of inflation making prices remain high, but the demand might start to swindle. When that starts to happen, I think there is a major risk in holding shares in AZEK, as they might be proportionally affected by it given their already noticeable decrease in volumes.

Risks

The building product industry faces a significant risk that can directly affect its growth and profitability - the volatility of raw material prices. Fluctuations in the prices of raw materials can leave manufacturers and suppliers struggling to maintain profitability, which can then have a ripple effect on other companies operating within the industry.

Looking at AZEK specifically, I think the rich valuation presents a very real risk of a stock price compression as the market prices the company more in line with the rest of the industry.

Besides the high valuation and the risk it brings to a portfolio, The AZEK Company Inc. seems to have been buying back shares with negative levered cash flows. I think this is a reckless road for a company to go down. It makes no sense, since that capital is much better spent at either building out what they already have instead of satisfying investors in some way. All in all, I think there are some routines here that need to change and they are enough to make The AZEK Company Inc. be rated a sell.

Valuation & Wrap Up

Right now I think the forward p/e of The AZEK Company Inc. paints the perfect picture of how the company might be performing in the future. It's sitting at around $43 right now and has been increasing steadily. I don't see a scenario where the company is able to justify this valuation. Because of this, you aren't buying the company based on fundamentals. Instead, it's wishful thinking the company is able to make it through the even tougher times that are ahead.

To conclude the article, I think The AZEK Company Inc. is a sell right now because the valuation presents too much risk to investors and there seem to be what I consider reckless methods used by the company. When levered cash flows are negative, there shouldn't be any program to buy back shares. That is unnecessary, in my opinion, and the capital is better spent elsewhere to fund growth and gain market share.

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