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

[Audio Gap] Tim Wojs, and I cover building products here at Baird, and we're very happy to have the AZEK company join us again this year at our Global Industrial Conference. AZEK is a leading manufacturer of composite products. They've got leading positions in decking, trim, railing and then also pergola markets. From the company we have CEO Jesse Singh; we have CFO and COO Pete Clifford; and then we have Eric Robinson over here who's VP of IR. So we're going to start with some slides from Jesse, and then we'll go into Q&A.

Great. If you -- here we go. Let me fast forward here. Great to be here this morning. I'll stick with the lav mic. We are in a quiet period, so I'm going to try to keep things at a very, very high level. So foundationally, we take recycled products and we turn them into exterior building products. And our focus is revolutionizing outdoor living and wood replacement on the outside of homes. And I think the key aspect is the interconnection between what I just said as our strategy and who we are and the financials of the company. We are a double-digit grower, mid-20s EBITDA, and we would expect our EBITDA to outgrow our underlying growth rate. And that's really driven by a couple of things. One is the categories that we play in, which are represented, as you can see on the screen here, are areas that are predominantly wood. So decking is one of our core products. It's 75% wood. We're going through our own analog to digital conversion; every year that goes by, a higher and higher percentage of the exterior of the house turns into our materials. One of the key aspects to our business is that we play in Deck, Rail & Accessories, but we also play in other aspects of the house that are also wood. So as you take a look at the picture that's up here, you'll see decking, you'll see rail. But in addition to that, you see all of that white -- literally white space, right? The white accents, the white accents around the doors, the white accents around the windows. That is the second major category that we play in, which is about 1/3 of our business, which is trim. It is the accent around siding. It's really the accent on the outside of the house. That is also predominantly wood and presents us an enormous opportunity. The other area -- everything on the back of the house are products that we produce. So in addition, we're not going to dive into it today, but there's a lot of adjacencies that we play in. There's things like column wraps, you see the shingle siding, you see other accents, and then obviously there's furniture on the deck also. Those are the categories within which we play. Macro way to look at this is over an extended period of time, we have grown, depending on the time frame you pick, 15% to 20% CAGR, right? This is our 10-year CAGR at 19%. We were growing coming into the pandemic at 15%. So we have had a long history of driving growth and driving above-market growth. We're either #1 or -- there are -- there's a little alcove here for those that want to do standing room in the corner here -- we are either #1 or #2 in the categories that we play. We are also typically the innovation leader in the categories that we play compared to our nearest competitor on the deck, rail and accessories side, as near as we can tell, we've got more than 10x the patents. And we also launch a product line every year, and that's foundational to us. What's different about us? We play in 2 categories. We're the largest vertically-integrated recycler of PVC in the U.S.; we take that unique stream and we turn it into products, including decking products. So we're the leader with a meaningful position in PVC decking. That also allows us to take recycle in other parts of the home. We typically are the more premium player in a market in a market that we play in. So on our decking side, we've got an incredibly strong position in the more premium segments. We also play in other premium segments, as I highlighted, on the exterior side, and we just recently acquired the most premium pergola company. There's some data here on adjacencies. Our core is $14 billion. Obviously, there's a tremendous amount of opportunity. Our business model is to always access adjacencies. And wood conversion, as I mentioned, is fundamental. That's actually a picture of, on the left, what the before was, and on the right what the after was. And that gives us a consistent accelerant to our growth. Strategy is very straightforward. Market conversion, so think about the market as the underlying R&R market, which is typically more resilient than any parts of -- than the remaining parts of the construction market. On top of that, we'll add someplace between 3 to 4 points of growth from just wood conversion. On top of that, we launch new products. On top of that, we see tremendous opportunity to continue to expand our channel position. So with that quick summary -- we're growing markets. The outdoor living segment tends -- right now is listed as the #1 area for architects for remodel. We play in that. We have a tailwind from wood conversion. We always launch new products. We take a portfolio approach to both growth and margin expansion. One element to connect on the margin expansion: the more recycle we use, the higher our margins. So for us, recycle is really, on a margin expansion play, free is a really good price to pay for a raw material. And then obviously, that leads to a very strong sustainability story. So with that, I'll take some questions from Tim.

Yes. Great. So thanks, everybody. Thank you for those comments, Jesse. If you want to ask a question, you can e-mail me at session -- I think this is 5 -- [email protected], it will come up here. You can raise your hand as well. And then just like Jesse said, I just want to be respectful that you're on quiet period. So -- maybe just start with the strategy. You've got a broader portfolio than most of your peers when it comes to outdoor living. Most of your other peers have decking, railing & accessories. You have trim, you have pergolas, those types of things. I mean, how do you -- how do you think about the conversion opportunity maybe more broadly than just deck boards?

Yes. Fundamentally, wood -- fundamentally, we're getting after wood conversion. Decking happens to be horizontal; our trim business and the other areas that we're accessing, wood siding and high-end siding and other accents, are basically the wall. It's the exact same opportunity. It's the exact same conversion story. It tends to be a bit more contractor- and productivity-centric, but it's the same value proposition. I think the other key point is, from a channel perspective, the lumber dealers that are -- that service the vast majority of the market and the retailers buy both in the same category. So every decking dealer has trim and every trim dealer, most of the trim dealers, have decking. And so for us, it's the same sales force calling on at least the same channels. And it gives us enormous synergy and opportunity and strength in the market.

Okay. From a penetration opportunity, your -- I think the industry is 25% or so now -- maybe what do you think the industry lands at the end of the year, 100 basis points of share?

Year-to-year, it's hard to look. I started 7.5 years ago, and when I started, it was 16% of the market was converted. Last year, I think the industry estimate is 25%. We expect typically a 100 to 200 basis point a year conversion. The anecdotal aspect of that is it's still happening. Year-to-year, it's difficult to pick a specific year or quarter on exactly what's happening. But the evidence is there, the amount of contractor conversions we have and the amount of consumers that are coming in, we're able to see that in the data, but it's hard to gauge the exact percentage at the end of the year.

How would you bucket like the incremental conversion in terms of the customers? You have some people, obviously, who have adopted. Like what's the pushback? Why haven't they done it?

Yes. So the research that we've done -- so if you take it 25% of the market is converted, that leaves 75% less -- 4x the market that's out there. And so there's 25%, give or take, that are just going to buy on price, right? I need to do something in the backyard, I'm going to take the absolute cheapest alternative. But that means that there is 50% of the market, double what we currently have, that list price as lower in their criteria. They want a natural-looking product. Visuals become absolutely critical to the conversion. And some of you have heard me say this: nobody wants to stand on a Fisher-Price deck, right? It doesn't matter what the conversion or what the sustainability or what the maintenance story is, it has to look right. And so for us, as we look at it in the various price points that we play, the most important thing is to get the absolute right visuals. And I think for the most part, give or take, we're about 90% of the way there to get after that 50%. So it's really important. Then it becomes a messaging story. Each of you in the room or watching on the webcast, you should order our samples if you're wondering what it looks like. The more of that that happens, and a lot happened during the pandemic, the higher the opportunity for conversion if you have the right product.

Good, good. And then when you think, this year, I'd say the decking market has outperformed other areas of the home in terms of renovation. Anything that anecdotally you've picked up as to why?

We went public 3.5 years ago. And when we went through that process, the -- there was a discussion on the resiliency of the business and why is this segment more resilient. And if you look back on the data on the 2009 housing prices, this category sustained itself. And so you think, why is that, right? A major driver of that is that we are always converting the market. So you have this growth stack that's on top of the market. So we believe that the market should always outperform the repair and remodel market by 4 to 5 percentage points just as a market. And then of course there's idiosyncratic elements that are above that based on each individual company. But it is what we would expect. We would expect this market to be more resilient than the underlying R&R market. And over an extended period of time, that's really what's played out.

And as well, outdoor living pre-pandemic was already a very high growth rate just in terms of a subset of the R&R market in general.

Right. Any questions from the audience? Over here, Matt.

You talked about how recycling PVC should drive margin. So you're -- as you grow, you try to increase that percentage of [indiscernible]. I just want to know about what that market looks -- can you talk a little bit about the availability of that [indiscernible] to access that [indiscernible] over time, is that market big enough to [indiscernible].

So the question is around, as we drive increased recycle, in effect, how is that market? The -- we use, and in my briefcase, I have some packaging materials from something I unpacked last night. Polyethylene bags, high-density polyethylene films and bags, on one side are a key raw material, along with recycled wood flour. A very, very small percentage of polyethylene films are recycled. So there is an enormous amount of availability out there and there is a market for people that consolidate that, that we can then buy from. So it's a pretty well-established market. And once again, it's really just this industry that uses it. You asked on the PVC side, which is in a similar application -- and these are deck boards that are kind of cut so you can see it, you can look at it later. We are -- we have built the supply chain. So we have tripled -- we bought a recycler in 2020, the premier PVC recycler. We have tripled their capacity. Once again, PVC at any scale is a product that's not recycled, it's landfill. And so think of all the siding and everything that's coming that's being generated. For the most part it's not recycled, a very, very small percentage of it is. We have plenty of supply. And so a long-winded way of saying we're well positioned to be meaningfully larger and have plenty of access to raw material. Which is unfortunate because that means it's going into a landfill, but it's also an opportunity for us to divert that.

A question right here.

I'm curious to hear your thoughts on the COVID impact on your [indiscernible] pre-COVID, say, decking was [indiscernible] in 2019. Like what happened [ during ] COVID and what -- where is the [indiscernible]. How do you see -- where you see [indiscernible]?

Yes, yes -- yes. I think if you go back and look at our last few transcripts you would see a discussion on that. But I think in general the way to think of it is we grow double digits every year. And that's really the foundation of how we -- organically, how we expect this business to evolve. Along the way, we had incremental pricing. And so that pricing added a bump. And then you start to look at the organic volume that's in there. I think from 2020 to 2022 we went through a bump primarily driven by inventory in the channel. So what happened is we had meaningful step-ups in pricing, so you have this accelerant. You have channel. Despite our best efforts, channel bought assuming that growth would continue, and they bought excess. So that has come out of the system. It came out of the system at the tail end, our fourth quarter of '22. And we stated earlier this year that we are done with the channel destock as of the first quarter of the fiscal year that just ended, which would have been a year ago. If you take all of that out, we're basically back to that double-digit plus price trend. So the way to think of it is the ups and downs in effect have normalized, and that's how we've been, on our last couple of earnings calls, really talking about it.

And maybe just talk a little bit about the price part, the double-digit. I guess during that period, plus price was positive.

Price was meaningfully positive.

Do you have a negative price...

In general, I think what we have said about this category and that the categories we play in, is historically we have not given back price. And as we have taken price up, we have priced appropriately to sustain the value in the market, such that we don't expect a meaningful step back. We did say this year that what we have guided within this year is, call it, 100-and-some basis points of increased, what we would say is -- not merchandising, but enablement or incentives as we have picked up share. But it's in that range. I think we said 100 and...

150 basis points.

150 basis points is what we said. I wouldn't call it a give back, it's just increased incentives.

Just a follow-up to the previous question. When you think about the percent of recycled [indiscernible], where does that stand today? What is the [indiscernible] target? And if you can quantify, what's [ left ] to determine the margins [indiscernible] you?

Yes. Specifically -- so the board that's made of wood and plastic is all recycled already. We're looking at lower and lower cost recycle streams, and that's where you get the incremental margin. On the PVC, we're up to -- I think what we've said on the last call is we're around 60%. During our analyst meeting or our investor meeting a year ago we highlighted that we can get incrementally above 70%, closer to 90%. In aggregate, I think what we have guided is that we see a 500 basis point opportunity by 2027. And that equates to about 27.5% EBITDA. So it's 500 from when we were 22.5% and call it, 2/3 of that, roughly, maybe a little bit more, would come from the recycle. And it's -- these are all highlighted in our -- in the deck that is available online from our June meeting. So we see meaningful opportunity ahead of us.

Just a question on, I guess, down cycle protection. You [indiscernible] higher data [ sector ] [indiscernible]. You guys sort of shared with us [indiscernible] wave that you were able to put in a more profitable formulation [indiscernible] and really protected that [indiscernible] margin. Is a move to higher recycle mix something that is in your DNA now during a down cycle as something that improves the gross margins at a time where maybe volumes are slow?

Yes. The high-level way I would answer it on kind of a couple of different elements is typically about 70% of our COGS is raw material. So we have a natural ability to scale our factories. And I think we have -- earlier this year, the first quarter, as we destocked our own inventory and as we took out inventory in the channel with a 50-plus percent decline in volume, we were able to manage through that appropriately. So I think number 1 is the way our factories are built are really modular, and so we have an ability to turn machines on and off. I think in our DNA right now, continue to accelerate cost reduction and the expansion of recycled is just pretty fundamental. It will protect us on both sides. So as there's material volatility on the upside, having higher recycle capability can help there and recycle does go down as we continue to drive lower and lower cost recycle streams.

I'd just add, the last 5 years, a lot of the conversation work has been on putting recycled into legacy products. And I think what's different in the next 5 years is a recycling is at the forefront when we launch new products. So we've got that advantage as we look forward.

On that point, how do you think about the cadence of new products? I mean, I know with -- you had kind of a cadence where I think every year you were putting out a new product, a product line or 2, and then COVID happened and then just the supply chain got kind of out of whack. I mean how do you kind of think about cadence from a product development standpoint now?

Well, the -- in order to drive wood conversion, you need to make sure that you are launching new products to access it, right? On the decking side, there's a little bit of a design element. So we're constantly -- reds, kind of reddish brown used to be in trend and then it went to gray and now it's -- actually, this color happens to be more on trend, right? And so you have to go through the cycle of always launching new products to facilitate that accelerated wood conversion. So we do it every year, and we would expect to do it every year. Our contractors and dealers are at a meeting right now, or they just finished over the last week, and we showed them what we would expect for them to be able to have for next year, right? And the other aspect to the cadence is we always want to grow our TAM. That's how you -- underlying, we can get to 10%, but we want to get higher. The only way to do that consistently is to be able to constantly access organically some additional markets, and we'll always launch new products there. And once again, that will happen like it's happened every year.

There's a hand over here.

Can you just talk about competitive dynamics for a second? So do you think the broader product suite gives you advantages over some of your competitors when you [indiscernible]? Obviously, there have been some changes in the competitive [indiscernible] in the last 5 years [indiscernible].

The -- I'll answer it at kind of at a modestly broader level. Our ability to provide a broader -- a broader suite of products that solve more problems for either the contractor, the consumer or the retail outlet, we believe, is a strategic and fundamental advantage of the business. Relative to competitive dynamics, as I've said in the past, we feel pretty good. And we believe we're strengthening ourselves every year from a competitiveness standpoint relative to what's around us. We feel like we're getting stronger.

And I'd just add a little bit on a kind of an infomercial on our Exteriors business. It's not been dilutive from a growth perspective. It's not dilutive from a margin perspective. It's a true wood conversion story, as Jesse articulated. It goes through the same channel. We are the #1 and #2 brands in the space. It's a fantastic business.

[indiscernible]

There's engineered where there is probably more technologies. It's...

I would say it depends on the segment. It's probably similar -- depending on the segment, it might be modestly more mature, and then other segments are less mature.

[indiscernible] highly correlated [indiscernible] in the next 12 months [indiscernible]?

The whole -- we've gone through an interesting cycle of talking about interest rates, talking about a lack of movement. There's a number of different things that, interestingly enough, the business has had, in 3 years, a chance to test against. We've always had a belief that we, and R&R in general, benefits from home equity, it benefits from resiliency in housing values, it benefits from employment, it benefits from asset wealth -- think of the stock market. So -- and we've said that for 3 years. And interestingly enough, the business, with the exception of that inventory correction, has been resilient across those 3 years. So we do view, given our demographic that we play in, that it's really -- I don't want to call it the wealth effect, but owning a house and having a job and feeling okay about your balance sheet are probably the things we look at more than whether or not the interest rate is 8% or 7% or 6%, because we deal with people that are living in their homes, not necessarily buying a new one.

And what's the -- I mean I know it kind of ebbs and flows, but like what data you have on like financing, cash, [ credit cards ].

The data we have that's publicly available is around 10% are financed. Intuitively, you would say maybe it's higher depending on the demographic, but it's in that range. At least that's what's publicly available. Yes.

Just real quick. [indiscernible].

Yes. We've taken -- we've made meaningful investments over the last few years on our brand. And so as years progress, the TimberTech brand becomes stronger, which is our more retail-oriented brand. Retail has historically been a little more than 1/3 of the market. As we've highlighted, for us it's only 10%. It was 10% of where we participate. As we've highlighted, that has been an accretive growth for us. We picked up some incremental share last year that we've talked about. So we view that as an ongoing growth opportunity as retailers are looking for more pro brands.

[indiscernible] it just seems like [indiscernible] products not growing this year and you guys are clearly outperforming in sales. Is there a way to [indiscernible]?

In general, we track it. We've looked at it in 2017, 2019, 2021 and this year. I would say we feel really good about our aided and unaided awareness vis-a-vis the rest of the market.

And then to that point, like contractor-wise, how much of your product do you feel like it's pulled by the consumer and how much it is kind of pushed to the consumer because the contractor kind of is in your corner and is always going to kind of push AZEK or TimberTech?

It's -- the consumer choice is on making sure that we get the right visual so that they want to use our types of products or our products specifically. It's a push/pull. It's hard to -- I don't know if it's 50-50, but clearly, our -- we were just at our contractor meeting and it's consistent over the years. Some contractors will not allow a consumer to buy wood or anyone but us, in other cases the contractor lets the consumer decide.

Okay. Well, I think we're about out of time. So please join me in thanking the AZEK team for being here.

Appreciate it. Thanks a lot.