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

Good morning. Welcome to the AZEK presentation. My name is Ryan Merkel. I cover building products at William Blair. Before we begin, I need to remind you that a complete list of disclosures and conflicts of interest is available on our website. With us today is Jesse Singh, President and CEO. AZEK is a leading manufacturer of composite decking and railing as well as other outdoor living products. The company has many advantages, including brand, innovative products and channel accents. Material conversion is a huge opportunity. Composite decking is 25% market share today and will likely go to 70% to 75% long term. AZEK is aiming for 10% organic growth and 500 basis points of EBITDA margin expansion by 2027, which makes it one of the better growth stories on my list. With that, let me turn it over to Jesse.

Great. Thanks. Appreciate it. I'm going to spend a few minutes, and I do realize I'm talking to a number of different folks in the audience that have perhaps different understandings of the company. And so I'll start at a very high level, let me get my clicker first. Just on the company. And once I get past the disclaimer, just to start on the basics, right? Our focus is around revolutionizing outdoor living to create a more sustainable future. And there's a lot of elements in that term, right? So one is outdoor living, right? And outdoor living is defined as the outside of a house. And I think that's a key characteristic and the ability to create outdoor spaces, both horizontally with our decking and rail products, but also vertically and with ruse with some of our exteriors products in our pergola products. As you take a look at a core part of how we operate -- it starts with our values. And I just want to -- I usually don't have an opportunity to talk about that. But fundamentally, it's core to how we win in the market, right, always do the right thing starts and ends with the customers. So one of the characteristics of our company is an obsession with the customer an obsession of having the best service and the connection with customers, I spend a lot of time with customers we are an outside-in built company. And then the next -- the last point I want to really highlight is lead through innovation. We have an objective of in every market we play in every segment that we play of being innovative and being on the leading edge. And so in general, what that means is you will see a broader product portfolio, you will see more new products. You will see more patents. You will see more differentiated technology. So just taking all that and to summarize really what we are, we take recycled materials and focus on converting wood on the outside of homes. So that's -- if you just step back and say, outdoor living, what is it we do? We focus on increasing the amount of recycle we use to create great outdoor living spaces. And I happen to have a couple of deck boards and to give you a context of why we are unique and why the industry is unique and why we are unique in our ability to do that. If you think about a construction of a deck board, there's typically a cap on the outside, and that's what gets the aesthetics. And that's where we have meaningful technical advantage and competitive advantage. But it surrounds a core. And that core, which in this case, this is not the way a product should be, we've shaped it down, so you could see the core. We have the ability to bury all kinds of stuff in the core of a product. So part of the benefit we have and how we operate in the decking space, in particular, but more broadly, is we're able to take recycled products and bury it in a product. And I think one of the things that makes us unique is we do it not only with polyethylene, which some of the other industry players do it with, but we also are the largest vertically integrated recycler PVC in the U.S. and perhaps we're not sure because we don't have data on the planet. So we are one of the few companies you're going to hear if any, talk about utilizing recycled PVC to make products, right? This is typically a landfill product. And where those products go? This is a visual representation of a meaningful part of our product portfolio. When we say a deck, rail and accessories, you can see if I can get the pointer right. You can see, obviously, decking here, we don't happen to have the rail, but when this decking is put down, there's lighting, there's fasteners, there's other aspects. And then everything else here falls under what we define as our exteriors business. So the white trim around the doors and windows, this white fascia, the column wraps everything in and around the corner of the house itself, that is what we define as the exterior of our exteriors business. So in many cases, it sits on top of siding. Now we'll talk later. We've launched some incremental plays in the kind of -- sorry, in the niche siding areas. But in general, think of the deck, think of the rail and everything else here falls under our exteriors business. And it's a key differentiating aspect for us because we have an ability to provide a more complete solution to our dealer base, to our retailers and to our contractors as they look to build out solutions -- we've got a very broad portfolio. These materials will be available to you later on. I'm not going to go through the whole thing. We also happened from a technical standpoint, happen to have 2 decking technologies, which differentiates us in the marketplace, and it allows us to skew more premium in the market. We recently acquired a pergola company, which is Smart Pergolas. We've got differentiated products in aluminum rail and then I've just chatted earlier about the breadth of our portfolio in the exteriors market. We've been built out over 20 years. So we have arrived to the products that we have, really starting in the late '90s where we branded AZEK to create exterior trim. It's the foundation of the company. And then we purchased TimberTech which was, at the time, the #2 composite brand in the market. And so we have brought those 2 together to create the broad portfolio that we just talked about. And what that's led to? If you think about what's unique, we're in a growth conference, we happen to be an industrial and a consumer-oriented business. What makes us unique, and I think Brian -- sorry, Ryan mentioned it, is that we are a double-digit grower. And we are a double-digit grower over a long period of time. If you look at our growth rate in our residential business over a 10-year horizon, it's 19%. And -- if you look at the growth rate in our residential business over a 5-year horizon, it's 19%. Our company is 15% over both those areas in general. And what that is driven by -- and we also have the capability to organically grow roughly 6% above the underlying R&R market. So I think one of the key things is we are built to be a long-term grower. But we -- against that, we've also built a really, really strong infrastructure in the market. So one of the characteristics of the market that we play in is that we are able to sustain reasonably high and growing EBITDA margins and gross margins. Now part of that, we believe, and I'll talk later is from our technology and vertically integrated manufacturing. But another key part of that is the structure of the market and how we are positioned within that market. So what you can see at the -- in the bottom part of this pyramid is we sell to millions of consumers and homeowners. Those millions of consumers and homeowners are serviced by tens of thousands of contractors, in our program, our loyalty program alone, we've got over 15,000. But in general, we work with almost 50,000 contractors that service those homeowners. In addition to that, those contractors buy from 4,000 pro dealers and a number of retail outlets. And they are serviced by logistically oriented distributors that deliver products to those locations in 24 to 48 hours.. So you think about the structure of the market and the complexity of what it takes to get into this market, what it takes to win in this market and what it takes to sustain growth in this market, you need to be able to cover the entirety of reaching consumers engaging consumers because this is a beautiful part of their home, they're building an outdoor space, you need to be able to engage contractors that are engaging the consumer and installing the product you need to be able to be in the locations that those contractors buy and you need to have the logistics network to deliver a product to those locations within 48 hours. And we do that across all of the U.S. and Canada, and it is a key part of our competitive differentiation and what our contractors and consumers rely on. Against that, we've built a number of different capabilities, both marketing and sales oriented to be able to win within that industry structure. So you think about our ability to sustain growth and you think about the opportunity that Ryan highlighted, which is margin expansion, that really comes from our value creation model. So we focus in markets where there are powerful tailwinds, right? R&R in general, has some really positive aspects to it. But layer on top of that, outdoor living is one of the -- is over the last 8 years, according to AIA surveys, the #1 area for home improvement investment. People want to build outdoor living spaces. When I grew up in Minnesota, we would have a lawn, we'd have these green launchers and we'd have carts. I don't recommend carts if you don't know what they are. I'm dating myself, but that was kind of your outdoor living space. Right now, people expect to have an outdoor room. That is additive to the R&R component. On top of that, there's a huge opportunity for converting an alternative material. Right now, the vast majority of outdoor living spaces are built with wood, deckings built with wood, rails built with wood, our exteriors business is built with wood there is a material conversion opportunity there. So our business model is to play in markets that have inherent tailwinds. So that's number one. Number two, we drive differentiated margins through a few key areas, right? Number one, brand. Our brand matters, the brands that we have acquired matter, and we're able to get a premium based on our brand. Number two, integrated manufacturing. We make what we sell, right? We are trying to be as vertically integrated, which as we can, as we move into recycle, we vertically integrate into our supply chain. Part of the value we have is our ability to make our own product. And then material science, which is technical differentiation and then customer connection. We operate with a very focused strategy, which I'll talk about in a moment. So let me just take a quick moment to talk about the markets that we play in. The markets that we -- even though we're a bit over $1 billion, the markets that we play in, our core markets are over $14 billion, and we have adjacent markets that are $10 billion. That's part of that inherent tailwind that we have as an opportunity, right? We operate in markets where there is a meaningfully larger accessible market, a meaningfully larger SIM that we can get after. And you can see these listed here. It's not just decking, it's the other areas. And then if you take a look at the wood conversion opportunity, that Ryan mentioned, that's talked about a lot in our industry. Right now -- so we went public in almost exactly 3 years ago. When we went public, we -- this slide and others like it basically said, 80% of the decking market is wood. And what we said is we'll have incremental growth because some of that wood will convert into our types of materials. Now we are saying 75% -- 3 years later, we're saying 75% of the market is wood. So we have seen over a 3-year period, a conversion of roughly 5% of the market from wood into our types of materials on the decking side. We would expect that to continue into the future, which is the tailwind we talked about. But then the question is how do you drive conversion of wood to our types of materials. -- right? Fundamentally, what our research says, if you look at that 75% of the market that's wood, what research would tell you is 1/3 of that or 25% of the market is going to be a price buyer, right? They're going to come in, they're going to look for the absolute cheapest alternative. If it happens to be wood, great, if it's composite, great, whatever it is, I just need to fix an outdoor living space. I need to fix something that's broken, that's about 25% of that wood market. If you then step back and you say 2/3 of the wood market is not a 100% price sensitive. What they're looking for is the right product with the right characteristics that will allow them to have the right outdoor living space. Aesthetics matter, the #1 barrier to converting the market is having the right natural look and aesthetics and feel. People don't want to stand on a plastically looking deck. And it's really important, and we've made investments in technology that we continue to educate the market that you don't have to sacrifice. You can get sustainability through recycle, you can get fantastic visuals and you can get all of the benefits of low maintenance. As we do that more and more of the market will convert. And we have the same opportunity. You can see on the trim and rail side, with our exteriors business. It's a very similar characteristic. Here's just some additional data on how the market has converted over the last few years. So you can really -- you can see that composites are gaining share. We believe that the next milestone for us I don't know if it's 5 years, I don't know if it's 10 years is that we believe we can convert another 25% of the market. I'll leave you with just a couple of additional comments, and then we can take questions. The other key aspect for the other key aspect for us in addition to growth strategy, right? So market conversion, product innovation, multichannel expansion and consumer journey, there's a couple of key aspects in our company that make us different. One is M&A. Our growth algorithm, as I said, rolls up to about 10%, and yet we've been growing closer to 15% to 19%. That delta is either better execution than our growth algorithm or selective addition of M&A. We are a selective acquirer of companies. The other key thing I just want to highlight is against that margin expansion, we are able to deliver against that goal of a 500 basis point margin expansion improvement by using continuous improvement like many companies do, but by also increasing the percentage of recycle used in our materials. That is a core part of our strategy. Every pound of recycled we use, that's not a virgin pound increases is half the cost or lower of its -- of the original material. So we've got a terrific margin expansion story. So with that, I'll summarize our growth algorithm. We stack 6 points, give or take, on top of R&R. Some of that comes from wood conversion. Some of that comes from growth initiatives, new products, channel adjacencies, that downstream focus. And that adds up to 11%, and we've got a commitment of expanding our margins by 500 basis points to 27.5% as we look at 2027. And by the way, that roughly equates to about 100 basis points a year of margin expansion as we start to move beyond '24. So with that, there's a lot of double clicks I could do in a number of areas. We've guided to a more normalized back half of the year. We're on a fiscal calendar that back half of the year, we'll start to show some of our -- the margin initiatives flowing through. And we continue to be well set up in our minds for not only finishing this year, but positioning the company for 2024. So with that, I guess I can open it up for questions for the last few minutes.

Maybe a comment on the health of the consumers and what feedback are you getting from contractors.

Yes. So the question was on the health of the consumer and feedback from contractors. As we talked about last summer, we saw from a peak, right? So we've had good growth over 3 years, consistent, by the way, if we look at 2019 to 2022, that growth is consistent with our growth algorithm. So we had some volatility within there. But as we talked about last summer, we saw a modest pullback in and actual demand, call it, mid-single digits from the peak. That has been -- that algorithm of a modest pullback of 5% is kind of carried through all the way to -- on unit volume flat on revenue has kind of carried through all the way to where we sit now. And interestingly enough, after that setback over the summer, what we have seen is very consistent sell-through and our contractors have had very consistent backlogs. And right now, without being specific to what we're seeing within the quarter, our general comments on our last call were that the consumer continues to be basically where they were with an ongoing process of repair and remodel and an ongoing process of continuing to fill the pipeline of projects on both the deck and the exterior side.

Maybe a comment on any trade down or any price competition [indiscernible]

Yes. So the question is on trade down or any price competition. As we have said, we operate with good, better, best premium. We tend to skew more premium in terms of our portfolio of offerings. And on the deck, rail and accessory side, even though we've gone through some inventory corrections and a modest slowdown or a modest pullback, as I mentioned last year, we've sustained our pricing. And part of the reason why is the structure of the market, the differentiation of our offerings and the fact that we do have these 4 tiers of products that allow consumers to choose. Now within those tiers of products, we have seen pretty consistent growth in our more premium segments. And we have seen nice growth in our, call it, opening price point front end, the good better segments. And part of our growth that we're seeing in the good and better segments is that we now have capacity to be able to service the market fully. We were under servicing the market on the good on the better side. And as we brought capacity on over the last 2 years, we're now able to more completely service the market. But long-winded way of saying, what we're seeing is basically no price competition aside from competing on features, attributes and price points within the area and pretty good growth across all the segments or pretty good consistency across all the segments.

[indiscernible]

Yes. So as you -- we are roughly -- when I -- over the last 3 to 4 years, we had about 6% to 7% of our business in the retail area and the vast majority going through our Pro channel. Our most recent commentary is that we're now up to about 11% of our business coming through retail. So retail has been accretive to our growth. And we expect it to be continually accretive to our growth. And we continue to do well in the Pro, right? So we've continued to pick up shelf space in the Pro. And then on the retail side, we picked up some incremental shelf space, and we continue to do well in the special order part of that retail business where it's not in stock, but you're able to order to the retailers. And I think a lot of what's driving that is the -- it really comes down to a few things. Number one, we are a really, really strong brand in the market. We are the Pro brand. And we have a lot of power through our brand. I think number 2 is now that we have capacity, we're able to offer a full product offering. And third, I would say is that we've continued to invest resources to cover the stores and to continue to engage the retailers in a way that allows them to grow their business by working with us.

Maybe, walk us through the [indiscernible] differentiation in terms of the customer journey just -- people that are new at the store.

Sure. At some level, so I'll do the deck rail and accessories side. So if you -- when you're a consumer of things, it's usually a personal journey, right? We all kind of go through these journeys of repair and remodel, et cetera. If you think about how a consumer engages this market, you own a house you look outside your deck's rotting or you see an opportunity to create usable outdoor living space by either expanding your dock or remodeling something, you make that decision you take a few different kind of parallel paths, right? Number 1 is you talk to friends, neighbors, what are you doing? What have you done? You go online, you research pictures. That leads you to manufacturers' websites. You start thinking about what's possible outdoors. For many of the people in the room are demographic. You are then looking for contractors, you're engaging a contract or you're finding a contractor. And you may or may not walk, but most people will walk through a retail outlet. And in a lot of times, they'll walk through the retail outlet or a retail store, a DIY or a major retailer and you won't -- you'll see, depending on the store and the location, you'll kind of get an idea of what's possible. But it's a lot of boards and lumber and all that kind of stuff. So then you pull back and you end up with your journey being focused online and with the contractor in many cases. And so -- and then it's a collaborative discussion with a contractor. In many cases, you'll find a contractor that focuses here or you're with a general contractor repair and remodel, you'll have the dialogue, you'll design your outdoor space. And depending on where that contractor is, they'll push a product or they'll have an open dialogue with you. And so that is common across many aspects. The main difference of many aspects of repair and remodel, the main difference with what we do is ultimately you end up having a visual choice, right? You're building an outdoor space. It's like choosing flooring or carpet or anything else. You'll then say, "All right, I need to pick what it's going to look like. And you'll look at samples, you'll order samples or the contractor will share with you a number of different options. And the visual matters a lot. You typically a consumer will pick it based on the visual once they've worked their way through the contractor process. And then you'll have a conversation maybe about what's the cost and all that other stuff, right? But I think it's important to understand that the journey doesn't start with what's the price of wood and what am I going to pay that's not wood. The journey starts mainly with the design, the aesthetics and then there's a conversation of price. And that's why it's so important to understand that we need to win that upfront discussion for us to continue to drive conversion in the market.

We're out of time. Thank you.

Great. Thank you so much. Really appreciate it.