New Portfolio Addition: The AZEK Company – Seeking Alpha

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Some investors may or may not be familiar with the latest addition to my portfolio. The company came across my radar by chance and before that was not known to me. For those of you who own a home and are doing outdoor projects you may be more familiar with their products, or you may not even realize it was a public company. The AZEK (AZEK) company operates in the outdoor living arena. I find this space especially compelling as recently the surge in home demand and time spent at home has led to an increased level of investment and spend around the home. The other large public sector companies that operate in this space have recently seen huge increases and demand and I believe AZEK will as well. Additionally, its closest competitor trades at a level of valuation that makes AZEK much more appealing as a way to play the sector. I believe the relatively unknown nature of the company being public has led to its undervaluation compared to peers. This gives new investors and opportunity to capitalize on the valuation dislocation.

The AZEK company is new to public markets and perhaps is why it is relatively unknown. The company is actually well covered by analysts with 15 ratings on the stock.

Source: Marketwatch

The stock currently has an average analyst price target about 10% higher than where shares currently trade. While I generally do not pay attention much to analysts it is a positive to see the target is higher than where shares currently trade. The shares have performed quite well since its IPO in June of 2020. The shares came out at a price of $23 per share and have only seemingly gone up from there.

So what does AZEK do exactly?

Source: Investor Presentation

Through a portfolio of brands it operates in both residential and commercial building solutions. The primary focus being on residential sales which make up about 84% of sales and over 90% of EBITDA. The most notable of its products is the TimberTech brand. This is primarily a decking solution that is composite which outlast and outperforms traditional wood decking options. It also offers exterior siding options, rail options, and other various products that contribute to its overall residential sales division.

Below we can see a better snapshot of the company and a bit of its recent performance.

Source: Investor Presentation

The company has been growing sales at an attractive clip noted as an 11.4% compounded annual growth rate and has also been expanding margins to quite attractive levels as well. As we can see, a majority of the company's sales come from decking and rail solutions and is primarily driven from the renovation and investment of existing homes. New construction also contributes to about 17% of sales which I predict will continue to be a strong tailwind as new home demand is outpacing supply and the average home continues to be upgraded to new all time high price levels.

The growth in AZEK products is primarily attributable to the fact that in the long run they are less maintenance.

Source: Investor Presentation

While installation costs may be a touch higher versus traditional options, the long run cost of maintaining the composite products makes total ownership cost come in at almost half. AZEK identifies the current market opportunity at around $7.6 billion in which it is growing 7% annually. As the homes built in the early 2000's continue to begin their upgrade and renovation cycle the company believes it can convert about 78% of potential customers to its product type.

Now, there is competition, primarily from industry giant TREX (TREX). TREX has seen its share price continue to reach new highs as it benefits from the very same trends we highlighted above.

Interestingly enough and unbeknownst to me, the TimberTech brand actually has as much recognition/usage as the TREX brand.

Source: Investor Presentation

Of further note is that the company is actually rated number 1 for the highest overall quality.

Of course the company is not just reliant upon residential sales, although it makes up the bulk of its sales. While commercial could be a focus for the future of the company to diversify sales away from being primarily residential, I believe it does not offer the same upside potential. The company has seen strong growth in its commercial division with sales growing 7.1% on average from 2015-2019. The company has made acquisitions in the last few years but those have been primarily focused in the residential space. I expect the company to continue to acquire in the future anything that may be complimented to its reach with distributors and consumers. However, I expect the company to be highly focused on brand reputation as it stands to be of importance to the current management team.

As the company has not been public for very long we have limited financial information to review besides what the company has provided investors.

The company has only reported once since going public, beating estimated on both the top and bottom line.

Source: Seeking Alpha

The company saw a slight overall revenue increase thanks to strong growth in the residential segment of 5.5% or $10 million. There was a decrease in the commercial segment which offset these gains however. The commercial segment reported revenue of $31.7 million down from $38.7 million or almost 20%.

On a positive note, the company gave guidance in which it expects sales to grow 12%-17% year over year and earnings growth of 14%-19%. This should lead to some healthy results.

As we can see below the company has been proving itself for the last few years with a continued trend of sales growth.

Source: Investor Presentation

Not only has sales continued to grow, mostly in the residential category, but earnings and margins have improved.

Source: Investor Presentation

With the margin profile expanding alongside sales and continuing to do so it is a healthy equation that should lead to higher earnings which usually leads to a higher share price. Additionally, the company used its proceeds from its IPO to retire debt and improve its balance sheet.

As we can see below the company stands in a position of financial strength.

Source: Investor Presentation

With $215 million in cash on hand and a term loan being the only real debt. This leaves AZEK with a 1.5x DEBT/EBITDA ratio for the current year based on expected earnings. This loan is due in 2024 and gives the company time to reduce it or refinance it at a more attractive rate. Considering current rates, it would make more sense to maintain a reasonable amount of debt so long as there is a better return for the use of capital.

While we need to wait to see earnings normalize, analysts expect the company to earn around $1 per share next year. I believe this is below what the company can do, but given that, the shares trade around a forward multipe of 37x earnings. Not a cheap price by any means.

However, let's see how that compares to peers.

Data by YCharts

The shares trade quite a few turns lower on both a forward P/E basis and P/S ratio than other distributors and manufacturers of outdoor products. This leaves room for AZEK to catch up once it proves itself a bit more as a public company.

I believe AZEK shares while appearing expensive on the surface have plenty of room for growth. The company operates in a space that is experiencing tremendous growth as evident by its fourth quarter forecast. Should demand continue to grow as expected by the increasing demand for home ownership and backyard living experiences than the company should continue to benefit and see increased sales. I believe this is the reason other public companies in the space trade at such premium valuations. My expectation is that as AZEK reports a few quarters of growth beyond analyst expectations the shares will move higher. The company stands in a financially strong position and operates in a space with limited competition and plenty of room for upside. For these reasons, the company has found its way into my portfolio.

Disclosure: I am/we are long AZEK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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New Portfolio Addition: The AZEK Company - Seeking Alpha