Now appearing in the Buffett-Munger Screener: Trex Company Inc. (TREX, Financial). As such, it made it through the screener because of its high predictability rank, its possession of protective moats, very little debt and slumping share price.
But has that share price fallen far enough to attract the attention of value investors? That will be one of the critical questions for potential buyers.
The company says on its website that it invented, defined and perfected the composite deck category. In addition, it claims it is the world’s largest manufacturer of wood-alternative decking and railing products.
Source: Investor presentation, November 2021.
Trex began with a buyout of a division of the Mobil Corp. (now ExxonMobil (XOM, Financial)), and followed up by going public in 1999. The company attributes its success to innovation, saying, “As the first company to combine the durability of recycled plastic with the natural beauty of reclaimed wood in a high-performance decking product, we lead the way in applying this proprietary technology to a wide variety of outdoor applications for low-maintenance, luxurious outdoor living.”
The company sees four growthdrivers:
And it lists four growth initiatives:
- Wood conversion.
- International sales growth.
- Partnering with new home builders.
- Cladding for exterior walls.
Trex lists wood as its primary competitor. Its presentation notes that wood currently holds 75% to 76% of the decking market, while composite has 24% to 25%.
Each 1% of the market it can take from wood decking manufacturers is worth more than $50 million.
Composite decking has four competitive advantages over wood decking; it does not:
- Rot, warp or splinter.
- Need painting, staining or sealing.
- Attract termites.
In addition, 95% of its raw materials come from recycled or reclaimed materials, giving it an edge with environmentally-focused consumers.
Data confirms those advantages or moats. For example, Trex had (construction) industry-leading margins and a robust return on invested capital of 27.38% at the end of its third quarter (Sept. 30, 2021).
In its 10-K for 2020, it reported that the Azek Company Inc. (AZEK, Financial) and Fiberon (a division of Fortune Brands Inc. (FBHS, Financial)) were its main rivals among composite decking companies.
Also in the 10-K, it shows itself easily outperforming two peer indexes:
According to the company’s 10-K, there are numerous risks, including:
- A small number of the Trex Residential customers account for a “significant” portion of the company’s sales. Losing one or more could pull down revenue, Ebitda and earnings per share.
- Conditions in the home improvement and commercial construction markets are beyond the company’s control. Slippage in those markets could adversely affect it.
- Raw materials might become an issue in three ways: prices might go up significantly, the quality of raw resources may be unsuitable or the company may be unable to secure enough additional materials to meet planned increases in production.
As the table and score indicate, Trex is a financially solid performer, with practically no debt and excellent metrics.
Take notice of the ratio at the bottom of the table, where we see the return on invested capital at 31.51% is roughly triple the weighted average cost of capital at 10.57%. This tells us the company is well managed and should throw off lots of free cash flow. The chart below shows it is—after recovering from recent pullbacks.
Regarding the two severe dips in cash flow, the company reported making heavy investments in capital expenditures in connection with capacity expansion, general plant cost reduction initiatives and similar costs.
Again, an excellent score. As all the dark green bars indicate, the company is leading the construction industry in profitability metrics. The only two exceptions, in industry terms, are the light green bars for Ebitda and earnings per share. Even they are light green, indicating above-average, but not excellent, results.
This 10-year chart displays more detail about the growth of revenue, Ebitda and earnings per share.
The following chart shows how Trex has outperformed AZEK and Fiberon despite recent pullbacks.
Its annual returns have been:
- Year to date: -36.74%
- One year: -16.54%
- Three years: 30.56%
- Five years: 37.39%
- 10 years: 38.28%.
Total annual returns over the past five years:
- 2022 to date: -36.74%
- 2021: 61.29%
- 2020: 86.29%
- 2019: 51.42%
- 2022: 9.52%.
Dividends and share repurchases
Trex does not pay a dividend, but has been whittling away at its shares outstanding, reducing them by an average of 1.76% per year over the past decade.
Over the past five years the share price rose rapidly, then plunged along with most of the market after Dec. 10, 2021.
The PEG ratio, the valuation metric for the Buffett-Munger screener, comes in at 1.88. That’s a bit high, considering the fair value mark for the ratio is 1. The five-year Ebtitda growth rate is 23.20% per year.
Digging a little deeper, we can check the bars adjacent to the PEG ratio on the table. The yellow bar indicates its ratio is about average for the industry and the green bar indicates that it is lower than it has been in the past 10 years. Perhaps this is about as low as the PEG ratio goes without another dip in the share price.
The GF Value Line assigns it a rating of fairly valued.
When the growth rate in the growth stage is set at 19%, the discounted cash flow calculator shows the stock is fairly valued.
The metrics give us several degrees of valuation, from modestly undervalued to modestly overvalued. For investors who would split the difference, the verdict would likely be fairly valued.
And that, of course, fits with the Buffett-Munger mandate of good companies at fair or undervalued prices.
The guru sentiment about Trex has been predominantly bearish.
Five of the investing giants held shares in Trex at the end of December. The three largest holdings belonged to:
Ron Baron (Trades, Portfolio) of Baron Funds, who held 3,308,290 shares, was good for a 2.87% position in Trex and 0.95% of the fund’s holdings, after a reduction of 7.71%.
Jim Simons (Trades, Portfolio)’ Renaissance Technologies owned 153,400 shares after reducing its stake by 6.29%.
Ray Dalio (Trades, Portfolio)’s Bridgewater Associates; the firm reduced its holding by 16.53% during the quarter to finish with 46,641 shares.
Could Trex become a stock for value investors, as well as one for investors who like Buffett-Munger stocks? I think so, especially if the share price dips a bit further.
From the perspective of value investors, the company has only a small amount of debt and what is likely a fair valuation. Moreover, thanks to at least a couple of moats, it enjoys strong profitability metrics. What’s more, it has strong growth prospects and may keep delivering industry-leading returns for the next five to 10 years. And like other Buffett-Munger companies, it has a high predictability rating.
It is, as the screener describes, a good company at a fair or undervalued price.