Trex (TREX) is the world’s largest manufacturer of high-performance, low-maintenance wood-alternative decking and residential railing and outdoor living products, notes Doug Gerlach, editor of Investor Advisory Service.
Outdoor living is one of the fastest growing categories within the repair and remodel sector, and the company was a significant beneficiary during the pandemic as homeowners invested in their living space.
However, the shares have declined more than 50% this year as higher interest rates have put a chill on housing-related stocks. We believe this presents an interesting opportunity to take a closer look at a growing, well-run company with attractive returns on capital.
Exterior property improvements capture nearly 40% of overall home improvement spending and continue to be the fastest growing segment of the home improvement market.
Trex estimates an $8 billion market for decking and railing and has led the move away from wood toward composite decking. Composite deck boards are more durable and engineered to resist fading, scratches, and staining.
Though Trex’s products typically cost two to five times more than wood upfront, lower maintenance costs mean lifetime economics favor composites. The company estimates average breakeven of approximately three years relative to wood once maintenance costs are considered, offering an attractive value proposition to the consumer.
The rapid increase in mortgage rates raises concerns regarding housing affordability and seems likely to cool the rapid rate of home price increases we have seen over the past couple of years. A flattening or decline in home prices would crimp expectations for near-term growth for Trex.
However, it is worth noting home improvement projects are strongly correlated with the equity homeowners have in their homes, and recent home price appreciation means overall home equity is at elevated levels relative to history. In addition, homeowners priced out of moving by higher rates are more likely to invest in their existing homes.
Given a continued shift from wood to composites, and Trex capturing more than its share of this ongoing conversion, we forecast the company will grow sales at a 12% rate. Margins are forecast to expand over time, which when combined with modest share repurchases results in earnings growth of 15%.
Projecting this growth over the next five years leads to EPS of $4.04. Applying a high P/E of 30.0, we get a potential high price of $121. Using a low P/E of 20.0 combined with trailing twelve-month EPS of $2.01 results in a price of $40. Therefore, we model an upside/downside ratio of 4.0 to 1 and a projected high return of more than 16% annually.
