TREX - Trex: Rebounding With Solid Foundations And Decent Gains

2023-05-10 01:47:13 ET

Summary

• Trex Company started the year with an impressive rebound.
• Its financial positioning is quite bothersome but remains sustainable.
• Market prospects are mixed, given the potential recession and the improving inflation.
• The stock price continues to decrease, making it a potential bargain.

Inflation, interest, and mortgage rate hikes have been challenging for businesses across industries. Building material providers were not exempt as demand softened in the second half of 2022. Trex Company, Inc. (TREX) received negative spillovers from real estate and construction companies. Unsurprisingly, the past two quarters showed massive revenue and margin contraction. Despite this, the company proved its resilience as it started the year with a robust performance. There may be more challenges ahead as recession fears intensify. But its current capacity shows it can withstand more headwinds and rebound. Meanwhile, the stock price remains in a downtrend after the massive drop in 2021. It is logical due to its hammered performance and bleak macroeconomic outlook. Even so, it remains lower than its intrinsic value with decent upside potential.

Company Performance

The real estate and construction market has enjoyed its boom in the past two years. The near-zero interest and mortgage rates led to a massive demand influx. However, the demand became overwhelming and raised property shortages. This uptrend raised property prices by almost 50% in only two years. As such, the demand softened and property sales dropped in 2022. In turn, Trex Company, Inc. felt the unfavorable market trend. Trex can also be considered a part of the consumer discretionary sector, making it vulnerable to lower consumer spending. Despite this, it remained durable and resilient to withstand headwinds and rebound.

In 1Q 2023, the operating revenue amounted to $238.72 million , a 30% year-over-year decrease. We can still attribute it to the lower production volume due to inflationary headwinds. Even so, it was a wise move to deal with the weaker demand compared to the same quarter in 2022. Also, we can see the continued rebound since 4Q 2022. The most recent five quarters revealed 3Q 2022 as the weakest one. It is mainly due to the peak of inflation at 9.1% , the highest in four decades. It had the lowest demand and pricing flexibility. Given this, the strategy of the company paid off in the next two quarters. The decreasing inflation was also vital in the rebounding demand. It increased the purchasing power of customers as their income adjusted to inflation. It was most evident in the property market as home sales and loan demand bounced back in the first three months of 2023. In turn, building products became more of a staple in the first quarter. The company enjoyed a substantial increase in demand from its 3Q 2022 trough. More importantly, the company had increased pricing flexibility. This aspect attracted more customers while stabilizing its production level. It was still lower than in 1Q 2022 but higher than in the second half of 2022.

What made it a durable company was its efficient asset management. In fact, costs and expenses remained within company expectations. Their combined amount decreased as the company reduced its production volume. Doing so allowed it to partially offset the massive revenue decrease. Although the impact of the lower volume was higher, the company remained profitable. The operating margin was 24% versus 28% in 1Q 2022. But it was way better than in 3Q 2022 and 4Q 2022 with only 10% and 16%. It was a massive rebound, which showed that the company has already regained its footing. And like its revenues, the increase was consistent from 3Q 2022 to 1Q 2023.

This year, Trex may see the same headwinds as average prices remain higher than pre-pandemic levels. The continued increase in interest rates may also pose threats since it may entice more savings rather than spending and investment. Despite this, the company may see hope on the horizon as policymakers continue to stabilize macroeconomic indicators. The company also maintains its market positioning with its good reputation and the recognition it received. We will discuss more of these in the following section.

How Trex Company, Inc. May Stay Afloat This Year

We can see how Trex Company, Inc. dealt with inflationary headwinds. It became more strategic to remain viable despite the substantial revenue decrease. This year, the same scenario may be seen. But the company must be more cautious due to the potential recession. The lower consumer spending may impact its production level. Another consideration is the pessimistic view of analysts of the real estate market. Even worse, some anticipate a massive crash. It may be the largest crash since the Great Depression.

On a lighter note, I believe it's unlikely, given the current market conditions. First, the skyrocketing property prices were driven by shortages. Even before the pandemic, the US was already dealing with property shortages. It intensified in the past two years as the real estate market boomed. In short, the massive increase in property prices was due to demand-pull, not cost-push factors. Second, property shortages remain high. In 1Q 2023, the US was short of 6.5 million houses . In April, it rose to 7.3 million houses . This shortage may help stabilize property prices and sales to prevent a crash. We can attribute it to the 9% decrease in property prices and demand rebound. The shortage can also be attributed to the conservative view of property builders since the Great Recession. Third, there are no speculative mania and unethical selling and lending practices in the market. The market avoids overselling properties to manage property value. Even before 2022 ended, the housing market regained momentum with nearly 30 million people wanting to purchase houses in 2023. In turn, the company may remain a staple as more potential property owners flock into the market.

Moreover, inflation continues to decrease. Although it stays higher than pre-pandemic levels, the Fed continues to stabilize it. At 5%, it was the lowest rate in two years and 45% lower than the 2022 peak. If it continues, the Fed may continue to ease its monetary policy. In fact, it only raised interest rates by 25 bps in two consecutive quarters contrary to 75 bps in 2022. Interest rates may keep increasing, but increments may start to cool down. If the inflation and interest rate trend persists, the recession may be milder and shorter than expected. Even better, the decreasing inflation can increase TREX's pricing flexibility further and take advantage of the current demand. It can easily adjust its production level at lower costs and expenses to sustain revenue and margin rebound.

Another potential driving force is the awards it received from different groups. While consumer behavior is not simple to quantify, Trex may become more appealing. It can increase consumer confidence and trust to capture more demand.

We must also consider its capacity to sustain its operations in a still challenging market landscape. Its Balance Sheet can show it. It can be alarming, given the massive cash burns in only a year. From $115 million in 1Q 2022, it dropped to $3.92 million in 1Q 2023. Despite this, we can see its accounts receivables reaching $302 million versus $211 million. We can say that revenues have been recognized but not collected yet. It accounts for 27% of the total assets, making it a liquid company. However, the company must still be careful to minimize uncollectible receivables or bad debts. Its borrowings are also bothersome. They have already increased by ten times and 90% of them will mature this year. With that, the company must ensure it has adequate reserves to cover it. It can either collect its receivables or refinance it with more borrowings. Fortunately, its Net Debt/EBITDA Ratio remains low at 1.24x. The company generates enough core earnings to cover its borrowings. It maintains decent liquidity levels to sustain its capacity while withstanding more headwinds. We can confirm it in the Cash Flow Statement, given the Cash Flow From Operations of -$115 million. But like in the Balance Sheet, we can see the massive increase in accounts receivables. The company continues to balance its growth and viability with sustainability.

Stock Price Assessment

The stock price of Trex Company, Inc. has been in a downtrend for over a year. There has been a continued recovery since 4Q 2022, but it did not rebound to its previous highs. At $61.04, the stock price is 10% higher than last year's value. Even so, it remains less than half its value before the correction. It was still logical, though, given the weaker 2022 performance and market pessimism. Yet, the decrease appears excessive relative to its fundamentals. There is also decent upside potential in its revenues if we consider its operating capacity and market risks and opportunities. We can confirm it using the PB Ratio, given the current BVPS and PB Ratio of 5.15 and 11.88x. If we use the current BVPS and the average PB Ratio of 13.4x, the target price will be $68.98.

Meanwhile, the company does not pay dividends. Yet, it distributes capital returns through share repurchases. They are decent and do not dilute company earnings. They also don't erode shareholder value, making it a potential bargain. If we get the cumulative EPS since 2019 and the net change in the stock price, returns have been high. The net change in the price was $19.15, while the cumulative value of EPS was $6.57. These show that for a $1 increase in EPS, the stock price rose by $2.91. Indeed, the stock remains attractive, given its impressive investment returns. To assess the stock price better, we will use the DCF Model.

FCFF $250,000,000

Cash $3,916,000

Borrowings $392,800,000

Perpetual Growth Rate 4.8%

WACC 9.2%

Common Shares Outstanding 108,804,000

Stock Price $61.15

Derived Value $64.31

The stock price adheres to the supposition of a potential undervaluation. There may be a 5% upside in the next 12-18 months. Investors may consider it a good bargain.

Bottomline

Trex Company, Inc. had a solid rebound from the challenging second half of 2022. Liquidity remains at manageable levels with its high earnings to sustain its operations. Market prospects are mixed, but growth prospects are attractive. Also, the stock price is undervalued with decent historical gains and upside potential. The recommendation is that Trex Company, Inc. is a buy.

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