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

Good morning. Thanks for joining us. This is the second session of day 1 of our 18-company Homebuilding and Building Products Conference, our 16th annual. My name is Mike Rehaut. I'm the senior analyst following the homebuilders and building products companies for JPMorgan. We're excited to have with us the AZEK Company, CEO, Jesse Singh; and CFO, Pete Clifford, are joining us. This will be a fireside chat. I have several questions prepared for the company. [Operator Instructions] First off, Jesse and Pete, welcome. Thanks for joining us. We're excited to have you here today.

Great. Thanks for having us.

I'm going to kick it off with just some questions around demand, mix. These questions, by the way, for those that haven't seen are already published in a report from yesterday morning. And feel free again for those listening to submit questions on your own, and we'll be happy to forward those along as well. So just kicking it off, thinking about market demand in '23 and '24, during your recent earnings call, you indicated that residential demand was trending a little better than expected, driving your market outlook for volume sell-through to be down maybe mid- to high single for the year instead of down 10% previously. So the question is, what do you think is, number one, driving the overall weakness in demand this year; and number two, the recently better-than-expected results?

Yes. So let me kind of start by putting a context here. So as we move through '22, the summer of '22, we had been running at, call it, double-digit unit volume growth for a couple of years, and we corrected in '22. And I think what we said as we entered into the fall of '22 that led to our inventory correction in the channel that we just went through was that we were running at kind of low single-digit revenue and negative volume in the back half of '22. So that was basically the set point coming into the year. And when we came into the year, we set a planning assumption, and I highlight that, which is, it wasn't a prediction of demand it was a kind of a baseline if we were down 10% in the market on a unit volume basis, here's what our performance would be. And I -- and we thought it was really important to pick what potentially would be the low point, right, down 10% on units. What we've seen year-to-date is effectively a continuation of what we saw at the tail end of last summer, give or take a little bit, right? So if you were to look at our dollars sell-out revenue. This is excluding inventory correction in our channel year-to-date through the end of March on a revenue dollar basis, our sellout is roughly flat to positive, right, very low single digit positive to roughly flat in that range, right? I'm not going to give you an exact, but it's greater than [indiscernible] right. And so then as you move -- so that has been modestly better than our planning assumption. Remember, we've got price in there. So I think one of the articulation points is we were giving you volume not dollars. Dollars is higher, we mix up at times. We've got great new products. There's a number of different elements. And we also included dealer inventory correction. So think of it now as on a dollar basis, flat to positive so far and down on units, makes sense, right? As we are looking moving forward, what we're doing is we're giving a conservative assumption for the next 6 months. And against that assumption, which, as we said, was, give or take, down 7%, but there's positive price and there's inventory correction in the down 7%. We believe we would have incrementally, give or take, enough to offset Commercial, which you should think of as give or take. I think if you do the math, about $40 million of revenue decline and $15 million of EBITDA against our planning assumption. So that's kind of the macro. Now what we're seeing in demand, we'll tell you when we conclude. But it's safe to say that the leading indicators that we highlighted on the call continue to be constructive relative to a decline. And so the way to think about it is we've gone through a bit of elevated demand, but as we ended '22 on a unit volume basis compared to 2019, we're up almost 30% on a unit volume basis. So we view the back end of '22, the inventory correction and all that to basically bring us to the normalized curve over a 3-year period. And now as we sit, we think it's appropriate to have a conservative assumption about demand and also a conservative assumption of where we're going to end in terms of channel inventory, right? It's not a projection of the future. We're just giving you what we think are appropriate assumptions given an uncertain environment.

Right. No, I think that those are important clarifications, Jesse. And by the way, when you talk about sell-through year-to-date through March being flat, you're referring to the prior 6 months. So you're referring to your fiscal year, correct?

Correct. Correct. Correct. Then there's minor differences month-to-month. But in essence, I wouldn't say there's a huge variation between the calendar year and the fiscal year.

Right. So I guess -- and I know you're not at the point yet to talk about 2024, but more kind of from a theoretical framework maybe even, but the follow-up on the demand question is any reason not to -- I mean, obviously, there's a lot of macro uncertainty. Let's say that the -- we're kind of working through this period of adjustment digestion of a significant amount of growth. The channel has obviously gone through a huge adjustment. To the extent that the macro kind of stays where it is, is there any reason not to assume a return to growth in '24, given all the various kind of secular tailwinds that we're familiar with in terms of outdoor and composite, et cetera?

Yes. I think one of the -- we -- Pete and I have a little bit of gray hair. So we've lived through multiple ups and downs in various industries. And what you typically see in any kind of a slowdown is you see, let's say, end demand is down 4%, 5%. But you see larger impacts when you deal with channel, right? I think the great thing about '23 for us is that we've seen that modest slowdown, and we've gone through a significant channel correction. And so the way to think of '23 is we got -- we will have had a lot of, call it, the correction behind us. And then as we move into '24, you're dealing with lapping a modest decline in demand if it materializes against our conservative assumption and you're lapping the inventory drawdown, which is typically part of any down cycle, and you have meaningful carryover of some of the initiatives and raw material that we talked about that you may ask about later. And we're lapping the P&L impact of a volume correction. So yes, I think the way to think of it is in a relatively stable environment, think of it down a little bit, up a little bit, we've already corrected. And so in effect, then you're left with real demand lapping some downturns and the benefit of our initiatives. And we feel really good about what's been happening in the market, our position in the market, the launch of new products, and I think we've said above the underlying R&R market between conversion and our own internal initiatives we've got the ability to grow 5%, 6% above market. So if we have a flattish market, we should be able to perform well in that market.

Right. No. And that kind of brings me to my next question, Jesse, and I appreciate that which is around share gains. And you mentioned in the last call or 2 some shelf space wins. So I was hoping maybe to kind of take a step back and then dive in a little deeper on this area. Number one, could you just kind of revisit your approximate share of the composite decking market and how that's trended over the last 5 years? And what initiatives you're taking to gain share going forward?

Yes. I mean specifically, so we -- one of the keys is to make sure that there's a clear definition of the market, right? The -- technically, the composite market excludes PVC, right? So what we've said is about half of our -- one of the strong advantages of our company is we have 2 product platforms in decking. One product platform is a composite deck, which is a wood plastic blend, and the other one is made out of Advanced recycled PVC. And so when we define the decking market, we look at, for lack of a better term, a view of the synthetic market. We're not excluding half our product portfolio. And so in that context, you should think of our share, give or take, around 30%, right? And once again, give or take, I'm giving you rough numbers. And part of the problem is when you look at the data over the last 3 years, it includes inventory -- it will start to include inventory correction, et cetera. And I think if you look at our guide, the last quarter, what we're guiding this quarter, if you just look at dollars, you're going to see us really over the last 2 years, you're going to see from a dollar basis, that the only explanation is that we're picking up share in the market, right? So if you go over a 2-year period. And so -- but roughly, you should think of it as, give or take, 30% and give or take, against that definition the other player might be 40%-ish or maybe a little higher in that range. That's kind of the -- I'm giving you a rough math. And then the question is, what's the difference in share position. So as we -- 5 years ago, so the macro market is, give or take, about 2/3 pro and about 1/3 retail. And retail being the big box players, that's the market. Our share, historically, when I got here was give or take -- or even 5 years ago, 4 years ago, was about 5% of our sales were into the retail channel. So if you think of that delta, right, 1/3 of the markets in retail, only about 5% of our sales are in retail. Now if you look where we stand right now and what we've talked about really over the last few quarters and at the tail end of last year, we currently sit at about 11% of our business give or take, roughly double digits focused on retail and then the pro. So if you look at the main share differences on a direct comparison, we are under-indexed in retail. And what we've also said is every year that goes by, retail has been accretive to our growth. So you can look at our growth stack and that kind of explains going from 5% to 11%, we would expect that we see opportunities to continue to have our retail growth be accretive to the overall growth. So we feel really good about our position. We feel good about our competitiveness, certainly having more capacity gives us an opportunity to continue to service the market. And I think the key step back here is I'm giving you the kind of the small universe of what's not wood. I think the reality is the biggest opportunity is how do we convert that 75%, that's wood, faster. So even though I may talk about share vis-a-vis competitors, the reality is what matters in the future is how fast can we convert the opportunity that is not composite. And growth really -- and share -- long-term share will come from the ability of us to combined as multiple companies in the space to convert that 75% and our individual ability to convert that 75%.

Right. No, I appreciate that perspective. So in terms of mix, in terms of product mix, we talked about this a little bit when we were on the road earlier in the year. How would you describe your product portfolio in terms of average price point or whatnot, versus your largest competitor? And how would that mix change over the next 2 or 3 years to the extent that you continue to gain more share in the retail channel.

Yes. I mean I can just speak to our business. What I would say is, if you think about the market as good, better, best premium, our Advanced PVC line, the TimberTech Advanced PVC product basically sits for the most part in best in premium. We've got some better in there but think of it as that product line given its attributes, it is inherently cooler, it's inherently lighter, it's a long-term environmental impact as we cross 60% recycle is actually better in many cases than other alternatives. And it just has the most premium look in the market. That particular portfolio makes up about half of -- as I've mentioned, our decking product line. And then as you look at the remainder part of our cap composite portfolio, we have also tended to skew more premium. So without being specific, I would say, historically, and it also relates a little bit to being in the pro channel, targeting wealthier demographics, greater SKU complexity, the model is really built to service the middle of the market and up in the most differentiated way. Now as I mentioned in the last 3 or 4 years, we've rolled out product lines that give us access to the good and better part of the market. We've continued to see really nice growth in those areas, in particular, the last couple of years, last 3 years. And I think moving forward, you should expect that we'll continue to grow and convert wood in the more premium demographics and linked a little bit to what I talked about earlier, we'll continue to have accretive growth in retail and accretive growth in some of those other areas. And so the way to think of it is the core will grow and continue to grow. And we've seen that even this year and that we might continue to use incremental capacity to continue to expand in all parts of the market.

Okay. I appreciate that. So I guess when you're thinking about the -- either your own share in the industry or as you can -- as composite/PVC continues to take share from wood, how should we think about -- because the -- and we've heard this a little bit from Trex as well or in their life cycle as well. The initial, I don't know, call it, 10, 15 years did largely focus on kind of a higher end price point. If you think back to perhaps 2018, 2019, there was a -- I believe, and correct me if I'm wrong, I'm a little newer to the industry initiating a couple of years ago, but my perception is both yourself and your large competitor kind of broadened out your product portfolio with price points that were maybe 50% below your higher-end price points. And this really helped continue to keep the industry on a pack of share gains as you're reaching out to a broader consumer market. So correct me if I'm wrong on that, just from a bigger picture, moving the steam liner ahead type of direction, and if that's the case in terms of how this industry moves forward that you're appealing to that not just maybe a higher end target segment, but the meat of the market, so to speak, how should we think about product mix and ASPs over the next 3 to 5 years from the industry?

Yes. I think one of the distinctions in dialogue that you're going to hear across the market is what drives wood conversion. And we've been pretty -- and part of it is where you sit in the market. So you're -- if you're on the shelf and you've got a wood board right next to a composite board, then your perspective might be that the best way to grow the market is to have that composite board be more competitive against that wood board on the shelf, right? I think for us, really, we haven't -- we have grown the market by having differentiated aesthetics and driven conversion based on that. So our own research says if you look at the market of wood, that 75%, about half of that market, more than half of that market, call it, 2/3 of that wood market is really -- they're choosing wood because they don't want something that feels unnatural or plasticky. That's kind of the general theme, right? And so for us, the unlock on wood conversion. And we've got a number of people that are listening to this. You all are our consumers, right? And if you think about what matters to you, of course, you want something that kind of fits your price point, but you want something that looks right. And fundamentally, our growth, in particular as we go from 2019 to 2021, '22, we've continued to drive wood conversion in kind of the middle of the portfolio up, right? So I think that there's a difference of dialogue. And so we don't assume that wood conversion, all of wood conversion requires an opening price point and convincing someone that they shouldn't -- convincing that 25% of the market that's looking for the cheapest thing. Yes. I mean, look, when we're converted 75%, then I -- and there's only 25% of wood left, then I think we can have that dialogue about that incremental might be price sensitive. But I think it's really important for us that when we view the market, we view the ability to drive wood conversion that sustains a nice mid- to premium portfolio. And I think sometimes we draw conclusions that if someone's going to put down our -- the price of our product relative to a decking job is, give or take, 20% maybe in an extreme case, 30%. And so think of it as you're doing all this stuff on substructure, you're doing all this stuff around the house. And on a relative basis, you might be dealing with $3, $4 a square foot difference to get something you want that's low maintenance. And so those kind of numbers are not an extreme difference in purchase for all demographics. And once again, I think the key is communication, accessibility giving people good products at good price points. So our good product that might be 1/3 of the price of our most premium product looks really good and is not an opening price point product. So it's that kind of a view that we have of the market. So I don't view -- there's been a low price point product on the shelf at a retailer for many years, right? So that wasn't something new. We didn't go under what was already -- what had already been on the shelf for 5 years. And so I just really want to draw the distinction that we see the opportunity of growth is giving people what they want, and we can continue to drive meaningful conversion based on that.

Right, right. I guess, 20, 30 years ago, maybe more, people never thought they'd spend $5 on a cup of coffee either. So quality and preferences can change.

Yes. Well, I'm going to -- many people here have redone their windows and -- or something like that. When you're doing that, you pick the window, and you pick something that's roughly the right price point. You're not comparing that window to the absolute cheapest option in the market. And I think that's a really -- somehow or other, we've kind of lost track of people are remodeling their house. They're choosing materials, they're choosing a contractor, they're doing it themselves. And a percentage of the market is just going to reach for the cheapest thing out there. But a more meaningful percentage of the market just wants it to look right and they wanted to hit their budget. And there is a lot of opportunity to give people the right thing. So it's not a $5 cup of coffee. It's probably more like a 7-Eleven or Dunkin' offering a good cup of coffee that's not $0.50, but it's also not $5. And I think that's the distinction here that people just want good stuff. And we can handle that in a meaningful way to drive wood conversion.

Right. Right. Right. Yes, I mean, yes, certainly, I was trying my point there about just people's views change on what they're willing to pay for things if it hits your quality threshold, so to speak. Kind of shifting a little bit still on price but from another angle. And I think this has been very, very topical over the last 6 or 9 months, which is, number one, the concerns around pricing pressure to the extent that there has been, a, the inventory correction; and b, the market kind of digesting some of the more recent, let's say, modest weakness and as well as price capacity additions. So number one, maybe you could kind of just remind us in terms of how pricing has trended over the last couple of quarters, how you think about pricing for not just yourself but the industry over the next 2 or 3 quarters, and then I'll have a follow-up as well.

Sure. I'll kind of stay high level, and I'll just use Deck, Rail & Accessories, right? Over coming in -- we went public in June of 2020. Part of what we said is if there is inflation, we have the capability and capacity to use pricing as a vehicle to sustain our margins. And so we have exposure to the broader economy. And in general, as you look out over the last couple of years, we've had give or take $220 million plus of raw material inflation that we have offset with price. Now that's across the whole company. It's not just Deck, Rail & Accessories, but I'll kind of stick with Deck, Rail & Accessories as 2/3 of the residential business. And I think what's key in there is we had already seen opportunity to go up in price. Prior to those -- we had done a lot of research on consumer price and opportunity in the various segments. And I think what this recent run-up has done is it's really accelerated the price opportunity that we saw in the marketplace. And so over the last 2 years, you can do the math, but it's meaningful north of 20% increases on pricing. So then moving forward, we believe that once again on decking, good, better, best premium, that post price increases, each of those segments is in an appropriate place and both from a competitive standpoint, et cetera. And I think the other thing we highlighted is, as we were adding capacity, is that capacity in decking would not alter the market structure relative to pricing. And when you're looking at meaningful volume declines, as you highlighted over the last couple of quarters, we haven't seen any change to that thesis. And so I think it's important that if you're looking for evidence, we've just gone through a pretty meaningful stress test relative -- and we're the ones with the most capacity that has come online. Our third facility is already up and running and -- the new facility. And so if you look at that thesis, it's held and we would expect it to continue to hold. And then in general, I think the way to think of how we would price things is we believe that the market in a market like ours, which is consumer, which is choice where we're constantly investing in technical differentiation, we should have the ability at a minimum to realize price in the future. I'm not saying this year or next year, but in general, at the level of inflation at a minimum. And I think that's -- as we move through kind of the noise of this year into next year, you should think of that we will continue to look at the market as being able to absorb a few points of price every year.

Right. No, that was the other part of my question, so I appreciate that. We have a few minutes left, and I do -- I always try and work in questions from the audience. Question is around current rate environment. And yes, I'll just read it off here, "Since your product is a higher ticket purchase, would you think that demand might be sensitive to interest rates? In other words, can you dive into any info available around how decks are typically financed, who the ideal customer is and if there has been kind of an element of financing, if that's been impacted at all in the last year with the higher rate backdrop?"

Yes, coming into the most recent rate cycle, I think we obviously -- we've been making public statements for 3 years. I think coming into the most recent rate cycle, we said that we didn't view rates as having a meaningful influence on repair and remodel in -- from where we sit. The data would indicate, give or take, 10% to 15% of -- now this is self-reported, but 10% to 15% of the market would experience -- would use a HELOC or some form of equity financing. We didn't have a meaningful concern on the impact of that. We continue to stress test it saying, is that a barrier? Do we need to support people with financing or anything like that. And the general feedback from the market was it is not a barrier. I think for us, the general -- and I'll repeat what we've said in the past here that as long as people feel comfortable with their wealth. And that's the value of their house relative to -- perceived value relative to its holding value, those kind of things, combined with general kind of asset net worth, how your 401(k) is doing, et cetera. And even though we've had market corrections, on a long horizon, people feel generally comfortable with their ability to continue to invest in their homes. And the demographic, first, we immediately subsegment kind of homeowners. So that's the first cut. And then within that, we're less oriented to DIY. We'll continue to expand by getting on the shelf where that is. But in general, our exposure is much less to DIY and much more to individuals that are moving forward with projects. And we track backlogs. We do about 1,000 contractor survey every couple of months. And in general, backlogs are higher than they were pre-pandemic on a self-reported basis at 8 weeks. And from the peak in 2021, it's modestly come down. But in the last few quarters, it's been relatively stable. So the backlog is also another indicator of this interest rate volatility has not necessarily influenced our pro contractor.

And when you say 10% to 15% of the market, are you referring to the outside of decking category or just decking?

When -- I just forgot the source, but it's a government survey that basically surveys for various projects, what percentage of the projects are using home equity lines.

Okay. So it sounds like maybe...

I can get that back to you. I unfortunately don't...

It sounds like it's a broader repair remodel statement. It sounds like to me.

No, I think in this case, it was decks.

It was, okay, fine. Perfect. Well, that actually does it. We're, I think, a minute over. So we'll cut it off here. I want to thank you, Jesse and Pete, for your participation. It's great to see you, and I appreciate you joining us today. We will continue at quarter of with Masonite, followed by our pre 2 mid-morning sessions, Beacon Roofing and D.R. Horton before our afternoon slate. So I'll let you guys go. Great to see you. Thanks again for joining us today.

Thanks again for your time. Really appreciate it.