Trex Company, Inc. (TREX) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Sue Maklari, I'm the housing analyst here at Goldman Sachs. And I'm joined this afternoon by Prithvi Gandhi, the CFO of Trex and Zach Lauer, the Chief Operating Officer. Thank you both for joining us. .

Thanks for having us.

Of course. So let's start with the near term and just talking about conditions a bit. Can you talk about how you would characterize the state of the industry today? And anything you're seeing in terms of just overall projects, anything in terms of sizes sophistication and any bifurcation between higher or lower end consumers?

Yes. So when the year started and when we were looking at kind of setting up what we thought 2026 was going to be like at the start of the year, we thought it was going to be another slow year with some potential recovery in the back half. And so that was the underpinning of our overall guidance at the start of the year. I mean as we went through the first quarter and then the second quarter in particular, we did start to see a shift in some of the demand. Some of this is deliberate kind of strategic moves made by us. One of the things that we sort of have been focused on over the last 3 years is really that wood conversion part of our strategy, which is really core to our growth and our ability to move composite decking into the wood. We really focus our efforts there. And we started to see sort of some good encouraging green shoots around that in Q2, which we talked about during earnings. And so that led to us overall kind of increasing our guidance for the full year. We started the year with sort of low single-digit type net sales growth for the full year. We're now kind of guiding to more of a mid-single-digit full year. And that's -- some of it is driven by that. The other piece is, I think we do -- we've been talking to all of you about there's pent-up demand in our market. We've been saying it for 3 years. We're actually starting to, I think, see some of that come through finally. And I think what's driving that is essentially the persistence of high interest rates, persistence of inflation, persistence of high home prices, it's really causing people's ability to move to really sort of be very constrained. And a number of homeowners are sort of making the decision now to just say, like, where is it going to stay put in our home. And so then they look at, okay, if I'm going to be here for another 5, 10 years, but where are the areas in the home where I want to make some investment, either to improve the quality of my life or make investments in the projects that I've been deferring for these last 2, 3 years because I thought I would move. And what's interesting is, and we did a survey about this about a month ago, we published the results in one of our press releases, so you can have a look at that. We've surveyed about 2,000 homeowners across the country, different price points of homes and so forth. And one of the things that came out from that is, yes, as we've decided to stay put -- one of the first places that rises up for investment is the kind of the outdoor living space because that allows them to enjoy their existing home more, like they spend time outside with their family, friends, barbecues, all that stuff. So that's -- and the size and the dollar value of those projects is also lower than like doing a full kitchen remodeling and what have you. So some of these things came out in that survey. And then also, I think what's unique about the Trex brand is it pays back in kind of value. And so homeowners when they're selling their homes, they list the appliances they have. If they have the high end appliances, if they have a Trex Deck, you can be sure they list that in the listing as well. So I think some of that is starting to happen. It's only been a quarter, so we're not calling a trend as yet, but we just remain cautiously optimistic for the rest of the year.

Yes. One of the other things that you talked about in the second quarter is that you saw some traction in the sort of lower end price points on a relative basis. Can you talk about that a little?

Yes. So this was deliberate -- we had a CEO change earlier in the year. And Adam's someone who's been sort of focused about on this. Over the last few years, our low-end price point, which -- our lower end products, which are Enhance Basics which typically sell against wood, we'd really see no growth in those categories. And so we really focus on driving growth there and a lot of that was through promotional activity and some of the marketing efforts that -- we've also been talking about that we started ramping up about a year ago with focused campaigns around why composite versus wood, et cetera. And so we started to see those things actually kind of come into play in the second quarter. Early April was a tough month. I mean I hate to blame the weather, but really it was about that. And starting in May, we really started to see good traction from those investments in that activity.

Yes. The other thing that has come up in the last couple of months is obviously the shift in distribution that you've announced. Can you talk a little bit about what drove that decision? And maybe also how it aligned with the broader operating and strategic goals that you've outlined?

Yes, good question. So just for those who are less familiar with Trex, so we made a -- we've had a long-term partnership with Boise Cascade, and we made the decision to shift away from them and have an exclusive national relationship with SBP specialty building products, which, again, for those of you who don't know them, they are a large -- within specialty building products distribution, they're one of the largest players, they're private equity owned, very -- growing very aggressively, both through acquisition as well as through greenfields and the like. So they're very well aligned with us in terms of their ambition for growth, their willingness to invest in leading brands and move them forward. And so from those perspectives, that's very aligned with our vision. And then the other thing we did with this change was to have a model where we had a strong national player or used to be Boise Cascade. And then we had a handful of really strong regional players. Then we kind of shifted to have even third players in some markets and kind of the things got a little more complex. With this move, we also made the decision to go back to that model where we had one strong national distributor, that's SBP, and then several strong regional players. So we added some new names like BlueLinx and Coastal and the others that we were already with. And so that's been the reason for making the change. Strategically, we think this will enable us to grow faster, will enable us to kind of drive more of the contractor pull-through that we see and are in alignment with SBP. And then with the change comes an opportunity to -- there's probably about $100 million of business from smaller brands that will be up for grabs over the next couple of years because of these moves. And we think we are very well placed to get that.

Yes, one of the other parts of the growth story is Little Rock. And you have announced that you're going to get that to 50% capacity by year-end. You sort of have pulled forward, I think, the ramp of that facility. Can you talk a little bit about that, Zach and how that aligns with what's going on?

Yes. Certainly, we're excited about that. We've had with the market changes and the destocking, right? Originally, we had planned to launch decking in Little Rock back 2025. With that slowdown, we pushed it out to 2027. But what we've seen so far, we're excited that now we're pulling it in, and we're ramping up that facility, and we have started to ramp up the decking capability there. We have been producing there for over a year on the recycling side. So to kind of we dipped our toe in there, started with the upstream processes and now are into decking. But for as a business, we've all kind of felt that heavy depreciation. We built big [ shelves ] there for the future. And so scaling growth now is not going to be as capital intensive for us because we bid off and built those shelves there, and we'll continue to benefit. I mean Little Rock has allowed us also to make sure that it gets the best innovation, it gets the latest technology that we have. at Trex. And then we also gain efficiencies in Little Rock. There was many reasons we chose Little Rock, and we've talked about this in the past, but the nearness of raw materials for us. Also, it lowers our operating costs from the standpoint that when we only had binodal manufacturing, we are pulling recycling and recycled materials from across the country. Now those don't have to travel as far to get to manufacturing. So more excited about that, and we're excited about what that facility gives us for the future.

Yes. And one of the targets that you've set out there is getting to $2 billion by 2030 -- of revenue, $2 billion of revenue by 2030. Can you talk about the role of both new products and maybe also how production and Little Rock and your capacity there fits in with all of this as well?

Yes. I think as we look out to 2030 into $2 billion, we see that not only coming from organic growth, but also mergers and acquisitions coming in the future that will help us get to there. But with -- when Little Rock is at full capacity, we have enough capacity to do about $1.8 billion to $2 billion of core product. So it's a big step for us in that space, too. . I was going to say, Prithvi, I don't know if you want to talk a little bit more about how like the $2 billion...

Yes. So I mean we -- so round numbers, if you use our guidance, we say we end the year by $1.25 billion or thereabouts. So roughly $750 million of growth over the next 4 years, we'd say about $500 million will come from organic growth, $250 million from M&A. And just one on Zach's point. So Little Rock is a really big, again, for those who aren't less familiar with Trex here, our manufacturing process is a very modular process. So it's line by line. And so the building we have really doesn't -- isn't filled with lines today. To get to $2 billion, we would add lines over time. But that is not a very massive capital-intensive exercise. Each line is in the order of $10 million to $15 million. So just to clarify that point. In terms of the growth, what we see, again, generally, our algorithm works as repair and remodel does whatever it does, typically decking grows 300 to 400 basis points above that. And then on top of that, we layer in the wood conversion story and some market share growth, and that's how you get to the mid- to high single-digit growth organically. So that's sort of the algorithm. In terms of the M&A, we're generally focused on things that are close to core because, again, we want to drive value if we're going to use capital for acquisitions versus I could -- we're doing a lot of share buybacks. We think that's a really good use of capital right now. For the M&A to win in that game, we have to drive real value. And the way we could do that is either we're buying things where we can use our assets to make those products, so think things like Pergola, sheds, furniture, et cetera, that uses extrusion technology and uses the types of materials we use today in our manufacturing and/or there's channel synergies. So we're selling through the same distribution, same dealers. Those things drive value. And [indiscernible], when we're looking at M&A that we really have that lens and then we look at it again, okay, if I look at this versus a buyback, what's going to win. The only other nuance here is that with M&A, we get growth, the share buybacks are great to drive the share price, but you don't get growth in new capabilities that give you future options. So that's the one sort of qualitative nuance that we always look at when we're looking at...

Yes. And the other thing that you've talked about is composite decking overall getting to about half of the industry. In this kind of a housing environment and a macro, is that still a realistic goal? And what drives that expectation?

Again, this is getting to 50% over time. Today, we're at 25%. About 10 years ago, we were 16%, 17%. So over time, I think, number one, it's the performance characteristics of the product. you get a lot more for spending a little bit more money. Like if you look at the cost of putting up a deck, and we have these things in our investment materials, again, for those who aren't as familiar, the cost of materials in the decking job is about 1/3 of the cost. And the rest is labor and everything else. And so for really not so much more money if you could -- you get a lot more performance. You don't have to maintain things as much. You don't have the routing and things that you have with wood. So that's really the big value proposition there around the performance characters of the product and its longevity. And I think over time, the things we're working on, and Zack can talk about this, we work on productivity, we work on things to drive the cost down. So we can keep that our goal is to try to bring the differential between pressure-treated wood and the lower end side of our products as narrow as possible so that you can actually then convert the customer and I don't know, Zach, If you want to add any...

Yes. I mean, certainly, at Trex, we've had a strong history of driving productivity. It's part of our DNA. Our operating model hasn't changed, and that's been on kind of 7 key pillars that we focus on. And within there, we're just using industry proven methodologies and tools within those pillars. And for us, we're a heavy manufacturer, right? Over 90% about what we sell is made in our own factories. And so safety is a big pillar for us. Quality, maintenance certainly is a heavy industrial manufacturer, but people, leadership is one of those pillars, initiative management, continuous improvement and workforce empowerment. And that's kind of when you go into Trex facilities, everybody kind of [ leads green ] because of our focus on our people from that perspective. But we've also done a very good job in there of driving a lot of automation. And when we think of automation and manufacturing, most people want to think about just what we're doing to take away like steps that may be had done before, right, as labor gets more and more competitive. But we've spent a lot of time over the last 7 years really in that machine learning generative AI space for us, which we think is going to continue to drive dividends for us as we move forward. And so we continue to modernize our manufacturing. And when we think of innovation, only one part of that is product innovation, the other is process and material innovation as well.

Yes, So it's really the reason we think we'll get to that 50% as a product performance and then bringing it to the consumer at a value that makes the conversion decision easy for that.

Yes. No, absolutely. Can you also, within that, maybe talk a bit about the digital initiative that you also have going on? You've been really focused on digital and the marketing side of things.

Yes. So a couple of things there. I think where we've -- I mean, we're doing things on manufacturing, and I'll let Zach speak to. But in terms of the customer-facing side of things, what we're trying to do is make it easy for end users easier for end users to make the Trex choice. So we've created a new AI-enabled app on our website where we've -- so far, we've just introduced it in a couple of areas, just we're still in the testing mode. But it's really for someone to build a deck visually virtually using AI. And then with the click of a button, they can sort of get connected to the local dealer or Home Depot or whatever and sort of look at the list of products they would need and then find the contractors in the area that they could work with. So we're doing things like that. We're also looking at doing things for the contractors themselves with apps and so forth that makes it, again, easy for them to do business with us, right? So they got a job, and there's a bill of materials that they need. They can easily send the order to the dealer, get their rebate from Trex, like all those kinds of things, that matters because that saves them time that allows them to kind of do jobs faster and gain more productivity. And so those are some of the things that we're looking at in terms of like improving the digital experience, both for the end user, but then also for our installers.

And then maybe with all this too, thinking a little bit about what it means for the path for margins, right, you talked about $100 million of incremental revenue, equating to 100 basis points of gross margin. Can you just talk a bit about the ability to deliver on that, the expected ramp and the timing?

Yes. So again, there's some assumptions in all of that, right? One of it is kind of that's at the current product mix with the current manufacturing footprint and so forth. But again, I think under those circumstances, as our utilization increases, it's really about that with -- as our sort of capacity utilization increases with every $100 million of revenue, we're able to generate about 100 basis points of margin. We haven't given guidance at '27, '28, et cetera. So we'll see kind of when that comes. But this year, we have headwinds because of the depreciation from Little Rock from the start-up of Little Rock. And then we still have railing growing faster than decking and railing is has margins that are lower than our consolidated margin. So those are some of the things that have near-term headwinds. But over time, as we utilize the assets harder and drive more volume, we'll be able to deliver on that?

Yes. And railing is something that we've seen has really been part of the story recently in the last couple of years. Can you talk about the growth that you're seeing there? And when does that perhaps get to a point where it's a more meaningful addition to the total business?