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

All right. Good afternoon. This is the AZEK presentation. I'm Ryan Merkel from William Blair's Research Department. 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 Peter Clifford, he's COO and CFO. We also have Jonathan Skelly, President, Residential and Commercial. AZEK is a leading manufacturer of wood alternative outdoor living products. It offers decking, railing, pergolas and exteriors that are all low maintenance. We believe AZEK is a superior growth company due to wood conversion, product innovation and retail channel expansion. With that, let me turn it over to Pete and Jon.

Good afternoon, everybody. Welcome. So we're just going to start with a brief overview of the AZEK Company. I'll kind of walk through a little bit about the product portfolio, our go-to-market, our advantages and our strategy and the hand over to Pete get into the financials. So simply put, our story is, we take recycled waste plastic junk, we turn it into highly sustainable, beautiful outdoor living products. So what you see there are bales of plastic trash and you see a bunch of formerly vinyl siding. We take those materials, we reprocess them, and we turn it into very long living assets for outside the house. So if you look at this picture here, a picture is worth a thousand words. We make everything on at home other than the stone or the windows. So the siding, the decking, the railing, even the furniture below. Those are very long-lasting, low maintenance, high-quality materials. And the big theme that you'll hear from us throughout the day here is it's all about wood conversion. For us -- I'll give you some statistics in a moment. But what we're trying to do is replace inferior building materials, such as wood, that rots and waste away and needs a high level of maintenance over time and replace them with a beautiful, long-lasting and sustainable outdoor living products. So a little bit of our statistics, I understand there's a lot on slides, so I'll try to work my way through it. The business is about $1.4 billion, if you look at our core product categories, Deck, Rail & Accessories is about 2/3 of the business. The other 1/3 is exteriors. So if you think about the decking and the railing that you just saw on the prior picture. That's going to be 2/3 of the portfolio, the siding and the trim that's going to be about 1/3 of the portfolio. In terms of how we differentiate our business, we are the #2 brand in the Decking category. We're the #1 brand in the Pro category for composite decking and PVC decking. We are the #1 brand for PVC exterior trim, our AZEK brand. So TimberTech is our go-to-market brand for decking and railing. AZEK is our go-to-market brand for exteriors. Given the growth -- the transition, the wood conversion from materials that [indiscernible] apart need to be maintained to our types of materials, which we call wood conversion. That has allowed us in addition to our growth initiatives to consistently deliver double-digit growth. So if you look at the 10-year net sales CAGR for the residential business, which is our core business, we are at 12% and if you look at repair and remodel growth over that same period of time, we've more than doubled it. If you look at the macro statistic that most matters to our business, it's going to be repair and remodel, that's a highly resilient market for us, whether it's over a 5, 10, 15 or 25-year period. The rate of growth for repair and remodel is around 4% to 5%. And so we are consistently taking that base growing above it with wood conversion and then our growth initiatives, which I'll talk a little bit about later, allow us to outperform and deliver that 12% CAGR. In terms of what we've been able to achieve over the last 20 years or our moat kind of what makes us special. We are a vertically integrated U.S. based manufacturer. So again, everything that we sell, we make, we don't outsource. One key raw material that we don't make ourselves is the aluminum that you see. So we buy the extrusions and then we assemble that into railing. But everything else, we are vertically integrated. So we start again with those trash bags that you see, and then we deliver the finished product out into the marketplace. For manufacturer, we have quite a large sales force, about 200 people. We are very focused on driving downstream demand in the marketplace. So we use a direct sales force to do that. Our direct sales force sells that product to our distribution partners. We have the best of the best in terms of building products distributors in the industry. And then we drive demand and we drive shelf positions at professional lumber yards, and at big box retailers. So that demand generation engine is really important to us. We get our products spec-ed in and on the shelves at those retailers. [indiscernible] is professional dealers, and then we create demand amongst both consumers and contractors to drive the pull-through from those positions. So again, roughly over 5,000 professional dealers, stock TimberTech and AZEK, you can find our over 4,000 Pro retail centers have our products available. And then we go to market and service over 15,000 contractors that install the product at homes like yours. So our long-term financial objectives, we want to continue to drive that double-digit growth rate while expanding our margins. Today, we want to expand our EBITDA margins to roughly 27.5%. That was our 2027 target. We were actually operating at those levels today. To give you a little bit more about the product portfolio, again, the broad portfolio is what makes us unique, what we've been able to do is utilize those material technologies that we know really well, PVC technology, polyethylene technology and aluminum and then we service low maintenance products throughout the outside of the home. So again, roughly over 5,000 professional dealers, stock TimberTech and AZEK you can find our over 4,000 Pro retail centers have our products available. And then we go to market and service over 15,000 contractors that install the product at homes like yours. So our long-term financial objectives, we want to continue to drive that double-digit growth rate while expanding our margins. Today, we want to expand our EBITDA margins to roughly 27.5%. That was our 2027 target. We were actually operating at those levels today. To give you a little bit more about the product portfolio, again, the broad portfolio is what makes us unique, what we've been able to do is utilize those material technologies that we know really well, PVC technology, polyethylene technology and aluminum and then we service low maintenance products throughout the outside of the home. So again, we have a leading decking portfolio, 2 types of technology, PVC technology and polyethylene technology, that's our largest business as we -- as I showed you on the pie chart in the earlier slide, high-performance composite and aluminum railing. So again, the complementary railing around the decking products that we sell. We then address the exteriors marketplace through trim and siding with our PVC technology. And we've got into -- through the acquisition of structures into smart pergolas and cabanas, these are aluminum, very similar value proposition to our plastics businesses where aluminum is also up to 50% recycled, powder coated, very low maintenance, long-lasting. You don't have to deal with rust and other things that you might with a steel structure or the decay of a wood pergola structure. So a little bit more about the marketplace. So a very large addressable TAM for us, about $25 billion in terms of our overall market opportunity. If you look at outdoor living, that's our primary area of focus. What makes us unique here is that we have a number of interesting tailwinds for the business that have allowed us to maintain that double-digit growth. The first is the overall popularity of outdoor living. So as a category, if you look at the American Institute of Architects and you look at where our repair and remodel spend is, highest proportion over the last 10 years repair and remodel spend has been outside the home, so outdoor living. So our core market is advantaged in terms of the popularity of repair and remodel investment outside the home. And then you look at wood conversion. So if you go to the right side here, what you'll see is 75% of the Deck market is still wood, right? So last year, over 75% of all decks made were still built out of wood, if you compare and contrast that to other outdoor building products, if you look at siding, for example, it's flip-flopped. Almost 70% to 80% of the siding on homes now is a composite material, not wood, right? So you see the opportunity for us to continue to take advantage year after year wood conversion. I'll show you some statistics on the rate of conversion here in a minute. But the same for our exterior business, 40% to 70% is a wood conversion or other material conversion opportunity. And within our Railing business, about 65% of railing can be converted from, again, inferior wood failing products to long-lasting, low maintenance, sustainable products. Decking, our largest business, $5 billion opportunity, exteriors our second largest business, $4 billion opportunity, followed by Rail, Pergola and Accessories. So again, very large TAM but very common characteristics across all of these is wood conversion, wood replacement, long-lasting sustainable materials that allow each of us to do less maintenance around our home. So picture is worth a thousand words. Stories are also important as my personal story. So that really crummy looking deck on the left, that was my deck. That was about 3 years ago. That deck was only 5 years old at the time. And I think we can all agree, it looks like c***. Now on the right, that's my current deck. And it's about, like I said, a little over 3 years old, it still looks the same way. Those columns are our PVC column wraps. They look beautiful. I get my kids out there with a pressure washer once a year. We hose it down, we're done. So it's really a pretty simple sort of value proposition here of the lifetime value, right? So while you might think you're saving a little money to install a pressure-treated lumber deck, in just a handful of years, it's going to look like [ how ] unless you really spend a lot of time of money maintaining it or you can go for the alternative, the fading and staining and structural warranty on the deck on the right is 50 years versus having to replace something every 5 to 10 years that's made out of wood and rock. So very simple value proposition. And if you look at the market opportunity, there are roughly 50 million residential decks in United States. 75% or greater of them are made out of wood, half of them are past their useful life, right? So there's this replacement cycle where you've got a lot of wood decks. It's not just an aesthetic issue, also becomes a safety issue, where you've got a wooden rail or wooden deck that your foot might fall through and might -- might be a safety issue. So Again, the value proposition, pretty simple, is that you get to replace something with low maintenance and your lifetime cost of ownership is going be significantly lower when you factor in that you don't have to do that annual standing, standing and maintenance and also a wood deck probably needs to be replaced twice over the same life cycle of a composite deck, right? So when you add up the economic value, it's a much better value proposition to go with composite. So what conversion? What's happening there over kind of the 2014 to 2018 range, you saw a rate of conversion of about 0.5% per year. What's happened since then is the aesthetics, the technology, the quality of the products has become significantly better ourselves and other manufacturers in our space have been educating and raising the awareness of the value of composite products and that's been accelerating conversion. So we went from about 50 basis points annually back from 2014 to '18 from '19 to '22, you've accelerated. So now you're converting over 100 basis points per year. Each 100 basis points of conversion is worth about 3% to 4% revenue growth to us. And so it's a nice multiplier effect on the business when we can drive conversion. For us, we see no reason why 25% today, composite penetration can't be 50% penetration in the not-too-distant future. So finally, our strategy to win, and then I'll pass it over to Pete for the financials, it's pretty simple. First and foremost, market conversion, right? That's a tremendous tailwind behind the business. That gives us the ability to continue -- to consistently outgrow the marketplace. Again, our track record has proven that, that we take repair and remodel growth. We stack on top of that material conversion and then our initiatives to grow and we can drive above-market growth. Product innovation is core to who we are. Each and every year, we're going to continue to bring new beautiful products to the market, expanding our total addressable market and allowing us to service multiple price points across the portfolio. But also, again, we're competing against wood. So each and every year, we want to bring you the technology that allows composites to be just as good aesthetically to wood. Multichannel expansion. We continue to expand this business geographically and through different channels. The Eastern Coast of the U.S. is much more penetrated with regards to composites. We've been investing differentially in Western part of the U.S. to grow our business. We also are investing heavily in channels like retail. So roughly 1/3 of the market goes through big box stores. Only about 15% of our business goes through retail. A few years ago, that was only 5%. So we've grown, but we're still under-indexed and that's a channel for growth for us. Consumer journey, if any of you have ever built a deck or resided a house, it's not easy. It takes a while. It's a very multi-month up to over a year journey. We see a great opportunity to continue to educate consumers, make that journey more efficient and remove the friction and continue to make -- improving your outdoor space through outside your home much more easy to do. So we make a lot of investment around improving that consumer journey, making it easier for all of us to improve our outdoor space. And then we have a successful track record of M&A. It's another way we've been able to do those tuck-in acquisitions, like structure, grow the business, both organically and through M&A. We're not a transformational acquirer, but we have a really strong track record of positive IRR tuck-in acquisitions. This is all underpinned by our ability to expand margins through our what we call AIMS, AZEK Integrated Management System, think of lean, think of process improvements. Every year, we're taking costs out of the business. Every year, we're improving our productivity, and that leads to margin expansion, which Pete is going to come up and talk about. So with that, I hand over to Pete.

Thank you. Good afternoon. So let's talk about the financials. So we have a philosophy in the company that we call you make a commitment, you keep a commitment. We've got a proven track record of driving strong financial performance over a long period of time. Our residential segment sales growth on the 7-year CAGR is about 16% plus 12% plus on a 10-year basis. Our EBITDA has basically doubled or more than doubled over the window and our quality of earnings has expanded over 500 basis points. Growth algorithm for the business is powerful, but it's a simple equation. The business is built off a base of R&R. So whether you think of 20 years, 30 years, 40 years, R&R in the U.S. has been really resilient and had a growth rate, generally speaking, in the 4% to 5%. So that's a base that we would build the business off of. Separately, our mission every year is how do we figure out how to deliver 5% to 7% growth on top of whatever the market is. How do we do that? As Jon mentioned, there's a couple of levers that we pull. First and foremost, that makes us unique is we participate in a [indiscernible] conversion story, where consumers every year are continuing to transition away from wood and to composites and at 1% conversion, it translates to the entire industry picking up about 3 to 4 points of growth annually. And as well, we usually have a list or -- growth initiatives really center around primarily kind of channel expansion as well as new product innovation that typically yields us a good 2 to 3 points of growth. So that's our pathway. In most years, we think we can consistently deliver about 10% organic growth. So what you see here is basically hedged. There's no price. There's no M&A. Those are obviously accretive and additive to the profile as we execute against those. From a margin perspective, we've got a portfolio of actions to drive the margin expansion story, the key levers that we lean into every day within the business. First and foremost, recycling is a pretty big bucket for us an opportunity. Recycling helps us really in 3 ways from a cost perspective. Obviously, we have an opportunity to increase the recycling content in our products, which is lever #1. Lever #2, in certain product categories, we're able to move to lower grade, cheaper forms of recycled material within our products. The third one is just lowering the conversion cost with which it takes for us to convert that recycled material. Other levers that are important in the business from a margin perspection -- margin expansion perspective, product configuration. Opportunities are there for us and think of that as just basically how we design and manufacture our product. There are ways that we can change our cap configuration to reduce cost. And then we've got more traditional [indiscernible] what I'll call just continuous improvement and those opportunities align around things like sourcing savings, scrap reduction, normal plant productivity as well as capturing the volume leverage that comes with growing the business about 10% on a unit volume basis every year. As well, we feel like between -- if we're able to achieve our growth ambitions consistently of about 10%, it's pretty easy for us to continue to support invest in growth while also achieving and maintaining and delivering modest margin accretion from SG&A leverage in the business of approximately about 25 bps is what we think. Those things all tied together, that gives us confidence that we feel like we can consistently in most years, deliver about 100 basis points of EBITDA margin expansion. If you think about the other outcome of strong margins and strong growth is, look, we expect to generate a lot of free cash flow. You should think of our free cash flow is generically about kind of low double digits as a percentage of sales. And our deployment priorities are pretty straightforward. First and foremost, we're going to support the business organically to grow. We're going to continue to focus and support CapEx to expand capacity to support growth. We'll continue to invest in CapEx and margin expansion projects to help us achieve the 100 basis points of margin expansion a year. As Jon said, we're not going to be a transformational acquirer but we will look to do strategic bolt-on acquisitions over time. That said, I still think that we will have excess capital left over after CapEx -- after M&A and our priority then would turn to a repurchase program. And I would say in the very near term, we may do repurchase as well as modest debt retirement. So to recap, we're unique in that, look, we have a double-digit growth story organically. We're going to continue to drive leadership in innovation and the best aesthetics in the marketplace. We've got a really clear margin expansion road map in front of us. We're going to generate a lot of cash, and we're going to be very disciplined deployers capital over the next couple of years. And as we do all that, look, what we're doing, sustainability is at our core and it's good to do all the things that we're accomplishing up above, but knowing that we're having a positive impact on the environment in the world.

All right. We've got time for Q&A. I'll kick it off and happy to take questions from the audience as well. First off, what are you hearing from contractors about the outlook for the decking season?

So what we've been hearing, Ryan, is that we're back to normalized stable demand, right? So if you kind of rewind back into the 2019 world [indiscernible] prepandemic, where lead times were roughly 7, 8 weeks, where contractors were getting -- the phone was ringing, but they were also engaged in marketing and engaged in driving their business versus just waiting for the phone to ring, those sort of stable market environments are back, right? So people are doing a great job of actually being able to show up to a consumer's house and take an appointment whereas they weren't doing that during the pandemic. And so again, really stable market environment amongst our contractor community, back to normalized 7- to 8-week kind of bookings and lead times and so we see a pretty stable demand across the United States geographically. We'll probably see -- we've been spending more on underpenetrated markets, both from a sales and marketing perspective. And so -- so we're seeing some better activity there and some payoffs there. But again, if you look at the entire U.S., we're back to very normal healthy levels of demand in the space.

And last quarter, you had a really big retail win. Can you just talk about why you won that business? And when should we see a sales lift from that win?

Sure. So what you typically see with retail partners is they conduct line reviews every few years. Typically, it's about every 3 years. So this past year, just a few months ago, we successfully secured some shelf space win at one of the major big box retailers and we will execute building the product now, and then you would look to see. We start loading in the product at the end of our fiscal year, which ends in September, but it's really a fiscal '25 opportunity for us where the material will hit the stores and we'll pull-through that material.

Last quarter, your sell-through was up double digits, which was a lot higher than your main competitor, and it's also well above where R&R is today. What do you think is driving that?

Yes. Look, I think fundamentally, it's a lot of the hard work that was put in, in their early by negotiations and just some of the share pickups in both the Pro as well as the retail channel. I suspect as we've not seen mix down in the business this year or last year. But I also think that potentially conversions may be a bit accelerated at sort of the higher end of the premium out of the marketplace, and I think we're probably benefiting from that as well.

Any questions from the audience?

[indiscernible]

Yes. So for us, with substructure this year, we launched an aluminum substructure product. And so what that does is that allows us to offer customers sub structure that actually equals the life of the deck boards -- composite deck boards that they're putting on top of it. So our product is aluminum powder coated. It can be cut and installed very similar to wood, but it's going to have a much longer life, low maintenance and the quality -- one of the things that we've -- part of our customer problem, we were trying to solve is complaints from contractors that pressure-treated lumber is at a different quality of what it might have been 10, 15 years ago. And so there might be an issue with installation where the lower quality -- lower quality wood might shift over time and impact the shape of the deck with an alternative substructure like aluminum, you eliminate that problem and it also has a faster install time than with substructure.

[indiscernible]

The deck boards themselves, we currently do not make structural out of our PVC or polyethylene technology. Today, we don't. There are companies that do. There are potential acquisition opportunities in that arena. But today, we do not manufacture anything structural from our plastics portfolio.

You mentioned wood conversion maybe getting to 50%. What does your market research tell you about 50%? Why is that the right number? And could it be higher?

Yes. I think our studies have kind of pointed towards the fact that there's about 25% of the market that is probably going to always remain kind of purely price-conscious and probably always choose wood. That 50% in the middle is basically open to composites. They need to be educated. The key for us is that from our study and our feedback, prices per [indiscernible] on the list of the decision-making process. So we think that plays to our strengths that we think the key to conversion is aesthetics.

One question I often get from investors is you have this exteriors business that I think is 25% of sales, something in that range. And your main competitor doesn't have that business. So why is that an attractive business? What kind of margin do you get there? And is it the same conversion opportunity?

Yes. It is our exteriors business is not dilutive on a gross margin basis. It's not dilutive on an EBITDA margin basis. For most of the last 3 years, it's been at growth rates organically that are at or above, our decking business goes through the same 2 steps of distribution. The primary material in our exteriors business is PVC. PVC is half of our decking business. So it's completely complementary to our [indiscernible] the material science behind it. It leverages our verticality on the PVC recycling initiatives, we have for decking. And again, it's core, it's still a classic wood conversion story. Now in fairness, siding and trim are a little bit further along. Decking and conversion, but there's still a lot of headroom for that space to grow, and we actually happen to own both the #1 and #2 brands within that segment.

Can you talk about the recycling initiatives that you have, where are you today? And what's the long-term goal?

Yes. So if you think about the 3 kind of major product categories, we've got our PVC deck business. We're approaching probably 65% as maybe an exit rate in terms of recycling content for this year. I don't know if we exactly stated what entitlement is. I think on our 2002 Investor Day presentation, we kind of said the next milestone was getting to 70%, which obviously we're well on our way to. I guess it's somewhere in the high 80s to 90% range is kind of how we think at least as a stretch target for content on the PVC deck side on exteriors. We'll approach 40% this year as we exit the year. Again, I think we had in our Investor Day about getting to 50% is kind of the next milestone, 50% to 60%. We have opportunities to move faster there, not only because the base is lower but also as we launch more products on the trim and siding side that can be painted. The difference between our exteriors and our decking business is, the decking product is capped. So you don't really see the recycling on the inside of the board. On exteriors, there is no cap unless you paint it and then the paint becomes the cap. So if it's painted, you're kind of unlimited and the amount of recycling effort you can put into it. If it's white or pure white and uncapped, really the constraint becomes how much pure white recycle post industrial, we can get our hands on to increase the percent and then on our [indiscernible] wood decking business, that's a 1 product where it's not really about increasing content anymore. Our recycling percentages, 85% plus. Our opportunity is to move to cheaper grades of recycled materials. So right now, we use about 50% high density, which is a bit more expensive and 50% low density and right in the middle of transitioning to 75% low density as a cost-out initiative.

And just the last minute here, Jesse talks a lot about improving the consumer journey. Can you just talk about what that means and how that helps your sales?

Yes. So I mean, I think it starts with helping educate and increase awareness to the overall category. And then once we've done that, have a more seamless process where -- okay. I'm in the market for a composite deck. I've gone to the website, I've done my research now. If I want to go somewhere to see it, can you direct me where to see it, if I'm ready to talk to a contractor, can you connect to me with the right contractor in my geography to further pursue the journey, right? If I have questions and I want to contact you digitally or over the phone, can you answer my call? Are there self-service options if needed? So there's just a lot of things that we can do that we're working on to make that relationship seamless, but yet sticky to where once we have that consumer engaged with us we more efficiently usher them through the process. We answer any questions they might have. We improve their ability to make the decision and then we make sure that we match them with a high-quality contractor who's ultimately going to deliver the outdoor space of their dreams.

Awesome. Well, we're out of time. Thanks, everyone. We appreciate it.