The AZEK Company Inc. (AZEK) Earnings Call Transcript & Summary

All right, everyone. I'm Phil Ng, Jefferies Building Products analyst. We're delighted to have the AZEK team here. Representing the company, we've got Jesse Singh, CEO of the company; Pete Clifford, CFO; and then Eric who heads up the IR front out there as well. So Jesse, do you want to kick things off with any opening remarks or anything? Bigger picture thoughts?

No. Just as a reminder, as you take a look at our company over the last 10 years, our residential business has grown 18% CAGR. We've -- at our most recent Investor Day, we talked about continuing a double-digit growth rate into 27% for the entirety of the business, built on a growth stack above R&R. And add to that, we talked about expanding our margins from -- at the time of the conference, 450 basis points, really driven by the combination of some price recapture from some of the headwinds we've had, combined with a focus on recycle and continuous improvement initiatives. So the business, as we've laid it out, is a double-digit grower with margin expansion opportunity, and it's really driven by secular tailwinds of wood conversion and then things that are specific to us, which really relate to a focus on new products, expanding into adjacencies and then continually driving incremental wood conversion across the outside of the house. And so with that, Phil, I'll turn it over to you.

Sure. When we think about your business through a cycle, certainly the last few years, you've seen nice drivers in the secular front. And through a downturn, heavy exposure R&R, which is a good guy, but should be less cyclical, but it's bigger ticker in nature. So kind of walk us through in a moderate type slowdown, how you envision holding up?

Yes, I think, first off, as I just mentioned earlier, we have multiple levers that we drive against the macro economy. We're always launching new products and some of the other elements I talked about that typically adds up for us kind of a 3- to 4-point stack above underlying R&R growth rates. I think the advantage we also have is as we're exiting this year, our fiscal year ends at the end of September, we've talked about a $30 million price net of raw material tailwind. On top of that, we have tailwinds associated, self-help type tailwinds associated with recycle and continuous improvement and actually normalization of operations. It seems interesting to talk about it now, but the last 12 months has clearly been impacted as we look at last year by COVID and other supply chain inefficiencies, all of which we're seeing move in the right direction towards normalization.

Got you. On that $30 million carryover price cost tailwind, that assumes cost is flat status quo.

Yes. On the $30 million, that's in line with the March CDI forecast. And candidly, the last 2 or 3 months have been a bit more optimistic about the amount of inflation carrying over to '23 being a little bit lower. In our mind, we're kind of using that as a -- not as a hedge, but as a factor to offset the fact that our plants are going to be running at about -- at reduced capacity levels through the first half of next year.

Got it. On that note, Pete, I think in the past, maybe your predecessor kind of guided to resin being about 20% of your COGS, right? So if I do the simple math, 10% move in resin, particularly PVC, that could be like a 5% tailwind on your EBITDA. Am I in the strike zone because that's potentially a pretty meaningful lever for you that differentiates you from your biggest competitor?

Yes. Another thing that might help is, look, as we've said before, we priced against the March CDI highs of about $220 million of commodity inflation that we were offsetting to get to not only $1 offset but a rate basis. And you could think of that $220 million, almost half of that is PVC. So any meaningful moves in PVC, obviously, have tremendous impacts on the bottom line of our business.

Super. That's great. The topic of du jour for the decking industry of late is destocking. You've guided to a pretty meaningful destocking, which is great because you're being disciplined as a market leader. Your competitor reported results yesterday, actually called out a pretty sizable one. Looked pretty big. But if you had to look at it from a context standpoint, is it sized accordingly? Is that a risk that we should be mindful, potentially more destock that you kind of laid out for us?

Yes, I -- so if you step back and you look at, first, as a company, you hate to alter annual guidance, right? We set annual guidance in November. And we're going to end at -- our year ends at the end of September. So you always want to do what it takes to hold guidance. I think as you look at the current guide we have -- the midpoint of the guide puts us at roughly 14% growth on the top line and give or take about 10% growth of EBITDA year-over-year after a couple of really remarkable years relative to our growth. And so even with the destock that we have put into our Q4, we end up with a 3-year growth stack at about 30% and on a unit basis for decking specifically just because that's an easy one to call out and closer to 60% on a dollar basis. And so we've had really, really good growth. In terms of the destocking that we talked about in June, we brought it up at our investor meeting. We chatted a bit about it. We knew that there was probably a need for destocking. We didn't know the magnitude until we ended June, and we got the data relative to how much inventory was in and the expected sell-through. With -- I think what we've guided now, we think that's an appropriate amount for where inventory is going to end and logically is going to end based on what our channel partners want and what we need to continue to sustain the business at the end of Q4. We gave -- our fiscal year starts in October. And as such, we haven't given specific guidance for how we see '23. And I think during the call, in response to a question -- during our earnings call last week in response to a question, I think Pete sized the additional inventory correction that could occur in Q1 is $0 million to $35 million. And we'll see what that is based on the data we have. But the intent there was to give you a sense that the sizable correction we believe will occur in Q4. And then as we move through Q1, we have to see the data, but we're -- once again, we're not guiding there. We're just kind of giving you a broad range in Q1.

Got you. So if we're assuming flat to down little sell-through demand, call the next 2 quarters or so, with the destock you kind of guided for Q4 and fiscal 1Q, would you kind of handicap that as channel inventories back to normalized levels or pretty depleted because your biggest competitor kind of alluded to maybe it's -- at least their guide -- their destock is going to position their channel partners at a very, very depleted level, and they see that restocking in calendar 1Q. So help us contextualize that.

Yes. I would say it puts us at depending on sell-through in Q1. Once again, we're not guiding to Q1. I think it puts us at the below, call it, 10% below a normalized year at the end of Q1, which is at the end of the year, right? And once again, our intent is, I'll come back to -- we're going to grow 15% top line, 10% EBITDA this year. We don't believe it makes sense to take a year off, right? Our intent is to drive growth every year, to drive profitability every year, and to make sure that we're servicing our customers without kind of overcorrecting. And I think this puts us in a position where we would see inventories below historical levels, which is where we think logically the channel could want to be, and then we'll see what makes sense as we move through calendar '23.

Got you. Sorry to pester you on this subject matter. One more question. I mean between you and your biggest competitor, you're flushing out a lot of inventory. The question we get asked a lot, especially with industry adding capacity. How do you see pricing kind of trending in that environment? Do you see any promotions discounting? And then in a weaker backdrop, do you see pricing holding?

Yes. I think the most important takeaway is we're sitting here in August and demand is good. And I think on a relative basis -- I can only speak to our business. On a relative basis, what we're talking about is allowing the channel to continue to sell their inventory in a very normalized way against normalized demand and then ordering a bit less from us. I mean it's a very simple equation. We're not -- we have a relatively simple set of SKUs. Those SKUs will be the SKUs next year. And they have been the SKUs -- prior SKUs. And I think the intent here is just to give our channel an opportunity to do a normal season, and the impact is really one that we as a supplier are going to feel. And by the way, we're -- everyone that's manufacturing or selling something right now, the way in which you balance inventory is you end up ordering less from your supplier as you sell what you have. And I think that's a pretty normalized environment. I think if we were having this conversation in January, it would take a lot more months to kind of bring down the inventory. And I'll reiterate on the -- what I've said relative to capacity coming online, we probably have the most that's coming on -- that came online recently. We're at about 75% to 80% above where we were in 2019. And we were running well before this last tranche that we brought on. The logical way we handle it is it's very modular, and you just don't run the machines. And so the impact, for us, as we normalize inventory is a pretty straightforward, running less lines.

Got you. Obviously, it could be noise in the next 6 to 12 months as we kind of -- consumers digest all this inflation. But long term, I think what's important is you feel pretty confident you could grow above market pretty handily, call it, 600 basis points. Does that assume the material conversion dynamic which has accelerated the last few years, pick up from here? Or is it pretty steady state?

Yes. I mean we've -- over the last couple of years, there's been a lot of questions on what is the conversion equation. Coming into the pandemic, I think we said it, it moved from 1 to maybe 1.5, closer to 2. During the pandemic, it's extremely difficult to kind of gauge the specific change. I think as we move forward, and you can see in our investor deck, we're assuming a pretty consistent historic conversion which I'd put in kind of 1% to 1.5% range a year, which gives you 4 points of growth, give or take above the underlying growth rate of R&R or wood. And we think that's a reasonable assumption. I think it's important to understand that our goal is to drive conversion meaningfully above that. But for planning purposes, we're assuming in that same range.

Got you. And then...

The opportunity is 50%. I mean we've got to get to that next spot of 50%. And we think we're launching the right products and doing the right things with channel to accelerate it, but we're -- we've got to do it before we talk about it.

Sure. And certainly, outside the growth story, there's a structural margin expansion and opportunity. I think you identified, call it, 500 plus by the next 5 years. How contingent is achieving those targets tied to, call it, double-digit growth if it's a more moderate growth environment, your confidence in hitting that target?

Yes. I think that's the one large advantage we have on the recycle side is, look, it's impacted by volume, but largely, the bulk of the impact is independent of volumes. So whether it's the shift to LD from HD or higher recycling content on PVC on both the trim and the decking side, both of those -- in our mind, those are the self-help levers that we have that we can control, again, independent of whether volume's double digit or not.

Got you. That's helpful. From an M&A standpoint, you've done a few adjacent acquisitions, which I think it's been attractive in the sense that it's adjacent. It's a new opportunity from a growth -- I guess what makes StruXure, INTEX a better fit part of AZEK? And then INTEX isn't a big deal, but I've always thought railing was an opportunity just because your attachment rate wasn't that high. Talk about is there any aspiration target on the attachment rate side?

Yes. I think it's a good question. And I think as you look at our company, we've got 2 platforms in the residential space. Deck, Rail and Accessories, which, by the way, includes porches and the front part of the house, too. And then we've got exteriors. And exteriors is, call it, niche products that are in and around siding, including trim and column wraps and those kind of elements. We made an acquisition a few years back called Ultralox. Ultralox was a niche aluminum rail player. At the time, we had very, very low volume on aluminum rail. And this particular Ultralox has a patented system that drives productivity with contractors. It's a panelized rail system. And at the time, it had less than $20 million of revenue. Since the acquisition, which is coming on 4 years now, 3.5 years, we have effectively doubled the core, more than double the core part of the Ultralox business. And we have brought that aluminum rail system into the AZEK channel and branded it TimberTech, and that's added tens of millions on top of that. So we've ended up with taking a modest, call it, $20 million-ish acquisition and turning it into a meaningful chunk of revenue. And I think more importantly, a more relevant component in our contractors' solution kit. So now you move to StruXure. StruXure has a really good business with pergolas where they take what is typically custom. So think about rail as protective decking and then overhead being what StruXure provides. They've got a terrific product. That business needed support to continue to grow. That core will continue to grow. And now they've launched a product that is much more set up for the core TimberTech contractor that we can bring right into that, which is Cabana X. So there's natural synergy there, and we would expect to not only on the operations side and productivity side, where we've driven 1,000 basis points of sequential margin expansion, but there's also revenue opportunity that we'll recognize over the next couple of years, similar to Ultralox. And then you talk about INTEX that we just acquired, it's PVC-based. We're big into PVC recycling. And it is a, call it, a niche premium rail product, which allows us to increase our attachment rate. And it also has niche exteriors products. And it's got a terrific brand with a terrific team, but is more narrowly focused in the Northeast, and we'll have an ability to scale that across the network. And so the core business there will continue to do well, and we plan on -- plan doing the same playbook. So those kind of acquisitions are incredibly accretive almost out of the gate.

Got you. Your exterior trim business is a great business. I mean benefiting similar structural secular trends like decking. Talk -- give us an update how that business held up? Were there some of the issues that you called out on inventory on decking as well for exterior trends?

We've had more consistent supply over the last few -- couple years during supply chain disruptions with the exteriors business. And I think as such, we've maintained a good supply base. And the inventory, call it, correction or realignment has been incredibly modest in that business, and some of that took place already in the third quarter. So we're in a pretty good inventory position there.

Got you. Any questions in the group? All right. I will continue. You have a much broader portfolio than your biggest competitor on the decking side and exterior trim business and you're growing out some of these adjacencies. Walk us through the value prop of having a broader portfolio? Does that really help you on the commercial side, is it in terms of gaining share with dealers and distributors? Just walk us through that dynamic.

Yes. So let me get you to kind of 2 points, right? So one is the point of interface at a contractor. On most decking jobs, you're cladding or you're wrapping a column or you're doing certain other things. And on an outdoor living job and many other remodels, you need both those products, right? Not in all cases, but you need aspects of both products to complete a job. We've got a complete solution there. I think as importantly, almost every one of our large -- all of our large decking dealers are also large trim dealers. They sell. There's a commonality. I don't mean distribution, right? We go through 2 steps of distribution. I mean the actual dealers that sell the product to contractors. And as such, it's important that we can engage that dealer base in addition to the contractor base with a more complete solution. So the categories may seem adjacent. But to a dealer, they are both 2 of their top categories, and it allows us to engage a dealer more broadly. And I think lastly, as we look at wood conversion, it really allows us to look at wood conversion in aggregate on the outside of the house where we can continue to sell high-value niche, high-margin products that leverage our core technologies.

From a recycling standpoint, the team has done a great job just starting this journey a few years ago. You're at GBP 500 million already. And you have an ambition of hitting GBP 1 billion. So it's effectively double, I think, by 2026. What are some of the gating factors? And is there an opportunity to kind of accelerate that process? And then lastly, I guess a question for Pete. As you can make that pivot, how should we size up that cost opportunity -- cost saving opportunity?

Yes. On the opportunity we had, if you look back a couple of years -- or really over the last 2 years, we deal with 2 recycle streams, PVC and polyethylene, both high density and low density, although we need to do more low density. As you look at those 2 recycle streams, polyethylene has a reasonably well-developed recycle infrastructure. PVC does not. So one of the gating items we had as we started expanding PVC recycling is just the ability to access the recycle and convert it. There's just not that much out there. So we have now completed a few acquisitions, and we put a fair amount of capital, and we continue to put a fair amount of capital into our recycling assets. In addition to engaging, we're now at post-industrial recycle, something about tearing siding off the sides of houses. So the gating item was infrastructure on the PVC side. We've resolved that. We're now well set up to go there. And then the second gating item was increasing our use of recycling. Having extra capacity that we do now puts us in a really good position to be able to continue to invest in the engineering necessary to continue to expand our percentage of recycle used.

Yes. And from a monetization perspective, we kind of said, look, there's 3 big buckets for the recycling, right? There's the decking shift from high density to low density. There's the increasing the content on the PVC decking side, and then there's also the content on the trim piece. And we've kind of monetized that at about 350 basis points as kind of the opportunity here in the near term. That's not entitlement. That's just sort of to get us to the next level of progress on the journey.

Super. And on the 500 basis points of margin improvement on the StruXure side, I believe that's mostly on the COGS line. On SG&A, is there an opportunity for you to kind of rein that a little bit? I know, Jesse, you've kind of built out the sales force team. That's potentially part of the step-up, but your SG&A looks a little more elevated versus some of your competitors.

Well, over the last 3 years, we have made pretty significant investments in SG&A. And as we talked about at the IPO, we believe there's an opportunity to drive SG&A leverage as part of our EBITDA margin expansion. As we've dealt with a pretty dynamic environment, we've gotten some of that leverage. And I think as we move through the latter quarters, our intent would be to hold that leverage. In other words, I think that there's room for us to be more efficient on the SG&A side. And we've already taken a few modest actions against that. When you hire as many people as we have over the last 2.5 to 3 years, along the way, some people need to self-select out. And so I think we feel pretty good about our ability to manage SG&A more efficiently while we continue to invest against our initiatives.

All right, guys. Thanks a lot. Really appreciate it. Great insights.