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

My name is Tim Wojs, and I cover building products here at Baird. And we're very happy to have the AZEK Company join us again at our Industrial Conference in Chicago. AZEK is a leading manufacturer of composite products, and they have leading positions in decking, trim, railing and the pergola markets. From the company, we have CEO, Jesse Singh; and then we have Eric Robinson, who is VP of IR. We're going to start with some slides and some prepared remarks from Jesse, and then we'll have a little time at the end for Q&A. So with that, the floor is yours, Jesse.

Great. Good morning. Great to be here. We are in a quiet period. So I'll go through a few slides that will give you a sense of the company, and then we'll be able to answer a few questions here. So start with who we are. As Tim mentioned, we are focused on outdoor living. We are focused on transforming outdoor living and expanding our use of recycled materials. So I think it's important to understand, our definition of the market is broad and focused on this transition that is going on where more and more people are focused on improving their outdoor living spaces. Fundamentally, our business model is taking recycled materials and turning them into beautiful outdoor living products. You can see here, we play in 2 different areas. One is polyethylene, which a number of composite decking players use. And then the other key stream for us on the recycle side is PVC. We are the largest vertically integrated -- we believe we are the largest vertically integrated recycler of PVC in North America, and we have taken aggressive steps to get there, and we think that presents us with a long-term opportunity. As you take a look at our portfolio, when we define outdoor living, we believe that we have the most unique portfolio in the market. It is a complementary portfolio: Deck, rail and accessories. And we have recently added to that, smart pergolas. So the way to think of it is flooring; rail; the pergola system is kind of a roof on an outdoor space; and then our exteriors business, which is really the wall. And as you take a look at exteriors in this particular picture, it is all of the white accent, with the exception of the rail, that's in this picture. So if you think of a repair and remodel job, whether it's a deck, replacing windows, upgrading your siding, the accent pieces is really where we play. And as you can see in this picture, there is enormous synergy between the 2 businesses. As you consider our differentiation. First and foremost, if you look at the decking side, we have both recycled PVC decking and recycled polyethylene decking. That is an important competitive distinction. In our business, about half of what we do is this PVC -- recycled PVC decking, and there's really not a comparable company in the marketplace. But we've also invested in capping technology that allows us to -- in many cases, we've been 5 to 10 years ahead of the market relative to visuals. I just talked about pergolas. We've recently expanded that. We also have, in terms of capability, we acquired a panelized aluminum rail manufacturer, which as productivity becomes the focus for our contractors, has become an incredibly fast-growing part of our portfolio. And then relative to the exteriors business, the way to think of that in our differentiation there is not only providing products that perform a function, but driving productivity for contractors, which has allowed us to really gain share with specialty applications. So as you think about the business, we really started this side of the business in the late '90s. We've been over 20 years of building out our capability. We believe we've got one of the largest, if not the largest, downstream sales force at 200 people that directly reporting to us. And as you look at our growth rate over a 10-year horizon, it's been 18% CAGR. And in general, as you look at that, we believe that we can drive, give or take, 6% to 7% above-market growth. Just a quick comment on industry structure. So if you think about our strength in the marketplace, we sell to millions of consumers that buy from tens of thousands of contractors that buy from thousands of independent or builder retail outlets and thousands of big box retail outlets. And as you look at the structure of the industry, to win in our markets, you need to win with the consumer, you need to win with the contractors and you need to win with the dealers. It is extremely complex for a competitor to make a meaningful inroad if they're not already entrenched in our marketplace. I just left an event last week where we were with over 100 dealers and over 200 contractors. Just to give you a size and a sense of -- and that was a relatively narrow meeting of some of our key partners. But that just gives you a sense of the scale at which we operate in the marketplace. So if you step back, you take a look at what is our business model? And we use this filter for acquisitions, we use this filter for adjacencies. We love material conversion. We love outdoor living. We continue to see more and more investment, a higher percentage of R&R dollars in outdoor living. We like the focus on R&R. One of the things that's not on the slide is -- in our slides, 85% of our residential business, we believe, is tied to R&R, with only 15% tied to new construction. Our core strengths: Brand, integrated manufacturing, material science and this customer connection I just described. And I'll talk a moment about our focused strategy. So if you think about the markets, what we mean by playing with attractive tailwinds, it starts with outdoor living. It continues to be, and our most updated data shows it, the #1 category for AIA in terms of repair and remodel. When I was growing up, we had jarts, we had lawn furniture, and we had grass, right? And you think of the transformation that we've been going through, of people creating outdoor living rooms, outdoor living spaces. And I think the second component is the resilient repair and remodel market. We have seen nice growth over the long haul over the last 10 years. We've obviously seen some elevated growth over the last couple of years. But even in downturns, this particular segment tends to be very, very resilient. And then the other powerful tailwind that we have that is always on the long haul additive to our growth is material conversion. If you look at the areas that we play in, A very high percentage of our markets are -- continue to be wood. Whether that's on the exterior side, where there's still 40% to 60% use -- wood used in the niche applications; or the decking side, where there continues to be a tremendous opportunity for that conversion. At our Investor Day, we highlighted a lot of research on this category. 25% -- so if you think about the market in decking, about 75% of the market is wood. Within that 75% of the market, 25%, give or take, is focused on price. So I know that there's going to be questions on what's the impact to wood. That will probably impact, in that 75% that's wood, about 1/3 of the market directly. The other 50%, when we surveyed them, is really focused on getting the right look, the right feel, of course, within their budget categories. But if you take a look at the data that we have -- and I was just talking to a contractor on Sunday, on their jobs, the deck surface is only give or take 10%, right? And so what's more important as we look at conversion is getting the right look, the right feel. And we believe, in terms of what we're doing with visuals and our investment, that we will accelerate the conversion of that. And you can see where we are now. We're given -- over the historic -- over a long historical run, we've been just over a percentage point of conversion. Every 1 percentage point in our market adds 4 points of growth, right? And we believe that we're kind of now in that 1.5 percentage point range. we believe that there is a meaningful long-term opportunity to continue to step it up, get after that 50% out of the 75%, the 2/3 of that wood market that wants the right look, but needs to be educated. So our aggregate strategy in terms of how do we drive growth. We talked about material conversion. Product innovation is key to us. It strengthens our core, it allows us to get the aesthetics to get wood conversion, but it also allows us to move into adjacent markets. Multichannel expansion. About 1/3 of the market is retail. Give or take for us, we only have about 10% share in retail of our residential business. And so there continues to be an opportunity within all of the segments. If you look at our -- we have great presence across the country, but we continue to see opportunities to expand what we do with our pro channel also. So there's great opportunity there. On the consumer journey, it's incredibly difficult, and it's part of what limits wood conversion, for many of us to go online or to contract -- contact a contractor to really drive that conversion. And then strategic M&A. So if you look at -- if you think about our 18% CAGR historically, some of the growth rates that we've seen. The model that we have is really built on, give or take, over the long run, about a 4% R&R growth market. On top of that, we believe wood conversion has driven 3% to 4%. And we believe our growth initiatives have and will continue to drive, and that includes everything I just talked about, 2% to 3% on top of that. So if you stack that up in our residential business, that gets us to about an 11% historical and future growth stack, once again, driven by that 4% R&R and the continued material conversion. And then we continue to see opportunity to drive margin expansion. We are still early in the recycled journey. As we've talked about, we've made progress, but we've also had a lot of headwinds relative to raw material that we've been pricing against. And so what we've talked about is, against that 500 basis points, about 100 basis points a year as we move to -- or higher as we move to a more normalized environment. So you can see the impact on our sales of that strategy historically, where we've had 17% in the last 5 years and 20% EBITDA growth. And so with that, I hit a number of different topics on those slides. Let me just summarize with how excited the team is with the opportunity that we see ahead of us. I've sat through a few other presentations or at least one other. They talked about the demographic opportunity that we have ahead of us. We've got multiple generations now competing for housing. We have a lot of recent housing turnover. We've got a large focus on outdoor living. And against that, we have a historically steady R&R growth. So -- and if you think about all those variables, you can start to see why over -- that we have been bullish and we continue to be bullish about our long-term opportunity. We're a leader given our portfolio. And what's fundamental to how we operate is that picture we showed, right, which is basically taking trash and low-value recycle and turning it into terrific products. So with that, I'll sit down and let Tim ask a few questions.

Yes. If anybody has any questions, you can e-mail [email protected]. Maybe just to start, Jesse, I mean, on the recycling piece. Could you kind of talk us through where you are today in kind of the various, I guess, subsegments of recycling? And where do you see that kind of going over the next 10 years? Because, I mean, to me, it seems like that's a big bucket of costs that you control kind of regardless of the environment. So how should we think about the recycling piece over the next [ little while here ]?

Yes. At our Investor Day in June, we -- and that presentation is still available online, if you're interested. We talked about in the next, give or take, 4 to 5 years, that we see about 350 basis points of margin expansion coming from our initiatives moving forward on recycle. Now we've already made progress. And let me give you a specific example. So if you think of PVC decking, right, which, give or take, is about half of our decking business, as we've talked about. Over the last few years, we -- when I got here 6 years ago, we were running at maybe 15% recycle. We talked about, at the Investor Day, of exiting our fiscal year at 60% recycle. We believe, and it's really just basic blocking and tackling, that we can get to about 90% recycle there. And similarly, all of that PVC trim historically has had incredibly low recycle levels. With the acquisitions that we've made in the recycle space, we now have an ability to bring our trim and exteriors recycle from very low levels, call it 10%, into the 30s. And so it's those kinds of things. And then the last thing is we are 100% recycled plastics in the core on our composite decking. But we use expensive -- more expensive recycled materials. We use high-density recycled materials. So we're about 50-50, the cheaper stuff and the more expensive stuff. We view a conversion to the cheaper stuff, which is low density, think of packaging films, the stuff you can't even put in the recycle bin. So if you add all that up, think of it as about 350 basis points. And with -- now that we've got extra capacity, which we didn't have for the last few years, really not since probably 2017, 2018, it gives us an opportunity to really accelerate that conversion.

Because you have the available capacity to do testing and all those types of things.

We have the available capacity, yes.

Okay. And then I guess that's all on the cost side. But then what about on the revenue side when you think about products? Because if I think of PVC being a higher price point, but also higher cost, if you can take the cost down, is there an opportunity to take PVC and the looks of PVC downstream over time?

Yes. So just to step back, we've got 2 categories: Cap composite and PVC. PVC tends to skew more premium. It's got a 50-year warranty. It has unique looks. It's a cooler product, cooler in terms of to the touch. It could be cooler otherwise, too. And it's easy to install. It looks and feels like wood. As we continue to drive recycle rates up, it takes out one of the most costly elements of that product, and it does give us the potential for flexibility. Whether we keep that in margin or whether we bring kind of those great characteristics of PVC to a lower price point, I think, remains to be seen.

Okay. A question here from the audience. Just how sensitive is the end consumer to financing, home equity values, those types of things?

Yes. And the research that we have -- and Eric, if you want to double click on it, go ahead, why don't you do the research up?

This is American Housing Survey data. But it would suggest that about somewhere between 10% to 15%, 16% of decking and kind of porch-like projects end up being financed by some sort of home equity or financing vehicle. So...

Yes. And I think in general, the -- as you think of this, these expenditures tend to be, maybe at the very low end, $10,000. The segment we play in. We play in a more premium segment, right? Our customers typically are affluent. I was talking to a Midwest deckbuilder, and their average is about $50,000 for an outdoor space. And think of it as $100 a square foot. And they're basically saying almost everyone just pays out of cash flow for that.

Okay. Okay. I guess from a share gain perspective. I mean, at the end of this year, I mean, where do you kind of think composite gets to? And I guess, why is the 1% or 1%, 1.5% conversion the right kind of number annually to think about when you're taking share relative to wood?

Yes. It's a good question. I think as we look at that conversion number, we're using historical data. It's -- conversion is an imperfect thing, right? It's a bit of a looking-back calculation. I think what we see is neighborhoods converting. And you -- the housing development was 2005, 2006, 1 deck converts, and then the contractor just stays there until the rest convert. And so it's -- we believe that we are seeing more of that, but it's really hard to predict something beyond historic there. We are hopeful and building towards a higher conversion rate.

Okay. Okay. And then how many decks do you think are in the market that need to -- I don't know if you want to say resurface, reskinned, replaced. Because there is the angle of, yes, there's a discretionary project, but also, there is a deck that could be 25, 30 years old that just at some point needs to...

Yes. I mean the data we have is NADRA data, which is Deck & Rail Association. They have said, about 60% -- or about 60 million existing decks, give or take; and about 50% are beyond their useful life. And many of you have probably gone, either your own homes or you've gone to someone's house and you can kind of attest that there's a lot of decks that are beyond their useful life, right? And so as you look at our market, we do have data that, when people replace a deck, 70% of them had no choice, right? And so there is a catalyst that's kind of built in here where you just have to do it.

Right. Okay. So from a capacity perspective, you've added your facility in Idaho. Some of your peers are adding capacity. And there's a fear out there that there's going to be a pricing kind of competition with kind of the slower demand trends and things we've seen. So it could you just talk about the 2 sides of the market, and how pricing has historically kind of play out with the industry?

So just a quick answer to do a little bit of simple math. What we said on the call, our last earnings call, was that, if you take the midpoint of our guide for 2022, we end at the end of September, which is why we're in a quiet period, it would equate to give or take a 30% unit volume growth roughly from 2019 to 2022. That's despite some of the call-down or the drawdown we see that we talked about in inventory. So if you just use that math and say we added 75% and we were shorthanded in 2019, you could start to see an equation where our exiting run rate in '22, we really needed a significant part of that capacity. So then to answer your question on kind of either -- and then there's 1 other component, which is a meaningful part of our costs are variable in our factories. So think about labor is variable. And 70%, give or take, of the cost of a deck board is raw material. And I think that equates similarly to trim. There's just a lot of material cost in what we do. And if you walk through our factories, which I know you've done, Tim, there is very little labor there. It's just machines and you turn them on. So it's very modular. So against that backdrop, what we have historically seen in either category, we have not seen a list price step-back, right? And we've done enough research in particular on both decking and trim, that we believe that where we sit now is the right price for the consumer. I think you would potentially -- we're a little bit more builder focused, or we're more builder focused on the exterior side. And so I think what we've talked about near the last call is you might -- on the exterior side, you might see a little bit more what we call programming pressure, which is think of kind of back-end stuff. And what we've said is our entire gross-to-net stack, which is that programming is, give or take, 6%, 7%, 8%, in that range, right? So we're not talking huge numbers there, but that's, I think, how we answered it after the last call.

Okay. Just on distribution. You've added some new distribution in, I think, Texas and kind of the Southeast. You've talked about retail, maybe trying to get more penetration there. Are there incremental investments you have to make in some of these distribution agreements? Or how should we think of kind of your ability to kind of continue to expand the distribution footprint?

Yes. So I would -- our market structure is a couple of steps. What we define as distribution is a fulfillment engine for the dealers or the retailers. So as we alter and other people kind of alter distribution, you should think of it as we are optimizing our service, right? And in an area where you were under-serviced, maybe you pick up a little bit of incremental volume, but you're picking up volume because you're servicing the market better. I wouldn't think of distribution as kind of a win. There are dealer -- we call it dealers, right, the pro dealer and the retailer. We always believed that there is opportunity for us to increase share at our dealer and increase share in areas where we are underpenetrated. And so we believe we have done a nice job of that over the last 18 to 24 months. And we believe that incrementally solidifying and expanding our position continues to be an opportunity there.

Okay. Good. And then just strategically, I mean you're building out a portfolio that's broader than just decking. So you've got trim, railing. You've got the commercial business, pergolas. How do you kind of balance kind of just leveraging the decking and the incrementals and the scale that you get from decking to try to build out a bigger company that's larger and has the same kind of material conversion opportunities?

I think the latter point is absolutely critical, which is we really like our business model, which is material conversion, higher-margin, value-added products, right? And could we launch commodity products? Sure. We're not going to do that, right? So we're really sensitive on that. As we think of these adjacent opportunities the StruXure acquisition and the most recent INTEX acquisition, they're both used by our existing contractors. And it's something they needed to finish a job. And these are nice businesses that tuck in that give us more relevance. We talked about conversations with channel. We talked about conversations with our end users of having a broader portfolio that helps them solve bigger problems is helpful in those conversations. Now I think what we need to work through, StruXure is a good example, and INTEX will -- I think we talked about it, is invariably, when you acquire people, we're kind of low to mid-teens EBITDA. And we need to take 6 months to a year to get them up to our level of EBITDA, right? And so we're not buying fixer-uppers, but when you buy a private company, there's opportunity there. And so maybe the downside is the investment is, it just takes time to get the EBITDA back to where it needs to be.

Have you seen -- I mean, have you been able to push those businesses through your existing channels? Or do they kind of operate separately? And can your contractor...

A little bit -- I'll -- so I'll give a little of both, right? So in the businesses we've acquired, they have a strong current presence. We maintain that. What we do is we basically take the products that they have, we productize it and we push it through our existing channels. So I'll give you an example. We bought Ultralox, that panelized rail business. It was a very modest business when we bought it. We bought it in 2018. As we sit in 2022, the impact of that is we've probably driven revenue up more than 3x from when we bought it. And that's that mix of both.

Okay. Good. And then just one question here from the audience. Just generally, how do you -- how have you seen raw materials kind of roll through? And like how does that kind of work through your P&L?

So just very high level, because I think it gets to some of the margin conversations, right? We've offset over $200 million of raw material inflation with price. We -- in 2022, we chased it. And what we talked about on our call is, by the end of the year, we expect to not be chasing anymore. But there is a lag in our business in terms of how it works its way through, so you might have a raw material decline. But there's a lag in terms -- I think we've talked about that as being in probably the 4-month range. And obviously, that's dependent on volume, right? If you run lower volume, that takes longer; if you run higher volume, it's shorter.

Right, good. We're out of time. So please join me in thanking Jesse, Eric and the AZEK team for being here.

Appreciate it. Thank you.

Thank you, Tim. Thanks, folks.