AZEK Company Stock: Finding A Floor (NYSE:AZEK)

In May of last year I had a look at AZEK (NYSE:AZEK) calling it a premium outdoor play at a premium valuation. The company has seen solid operating momentum coinciding with strong share price performance as well.

The valuation was far too steep to find any comfort, despite a sound long term positioning, as shares have lost some 50% of their value, even as the operating momentum has been solid. This creates an interesting set-up and while I like the business, and this situation, overall valuations remain quite demanding.

Former Take

AZEK focuses on outdoor products, notably wood-alike products (made by PVC and plastics), which are used in decks, rails, trims and accessories. Nice aesthetics, low-maintenance and sustainable products provide compelling reasons to use the products. The company has US manufacturing operations and serves the market with its namesake brand as well as TimberBech.

The company went public at $23 per share in the summer of 2020, as the timing coincided with the boom ignited by the pandemic of course. Shares rallied to the $30 mark on the first day of trading, valuing the business at $4.7 billion on an enterprise basis at those levels.

This valuation was applied to a business which generated $794 million in sales in 2019 on which operating profits of $59 million were reported. Pegging earnings at just $0.25 per share based on those numbers, I naturally was very cautious even as the company has seen a big boost from the pandemic.

The company posted 15% revenue growth in the first half of 2020, but we have to remember that the book year ends in September, so no real pandemic impact was seen yet in the results. With earnings doubling, earnings power could see a boost to $0.50 per share, comforting, but still working down to premium valuations at around 60 times the annualized earnings power at the time.

Shares only rose further in the first year of trading as they hit a high around $50 in spring of 2021. This came as the pandemic actually lifted operating momentum for the business with full year sales coming in around $900 million as operating profits came in around the $100 million mark, with earnings coming in around $0.50 per share, in line with the earnings power estimated by myself.

In May of last year, the company posted its second quarter results with solid double-digit percentage sales growth, indicating that operating profits might run at $150 million per annum, pushing up my net earnings estimates to about $0.70 per share as that was the last time I had a look at the business.

While that is superior, it worked down to a 60 times earnings multiple, a huge multiple as the business was on fire already in terms of margins and operating conditions, with conditions being ideal to post strong earnings, leaving me wondering in which conditions earnings could rise further. Continued offering of shares by selling shareholders was not a very comforting sign either.

What Happened?

Since voicing a cautious tone in May of last year, shares have traded in a $35-$45 range, actually trading toward the high end of the range by year’s end. Ever since, it has been inflationary concerns and higher interest rates which cast a doubt on the outlook for the housing market and consumer spending on related categories. In fact, shares have lost half their value since the end of the year, now having fallen to just $22 per share.

In November of last year, the company posted its results for the fiscal year of 2021 with revenues up another 31% to $1.19 billion as the company posted an operating profit of $142 million on which the company reported net earnings of $93 million, equal to $0.59 per share. Net debt fell to just $218 million, at less than 1 times EBITDA.

The company guided for further growth in 2022, as this is too shortsighted to call the company merely a pandemic play, as there is a real secular growth story to the investment case as well. The company guides for growth in the mid-teens in terms of sales in 2022 and high-single digit growth in adjusted EBITDA.

In January, the company announced a bolt-on acquisition with the purchase of StruXure Outdoor, a designer and manufacturer of quality and innovative aluminum pergolas and cabanas, basically adjacent markets to the core decking market. No purchase price was announced as the deal was set to add some $50 million in sales, indicating a roughly 3-4% revenue contribution, with a similar margin profile anticipated as the own business.

Following solid first quarter results, the company updated that guidance to reflect for the bolt-on dealmaking with full year sales seen up 19% at the midpoint of the guidance and EBITDA seen up 20% on the year before. Dealmaking and seasonal impact made that net debt rise to $399 million, no major concern given the profitability of the business with EBITDA set to comfortably come in above $300 million this year.

Assuming 20% growth applies to earnings per share as well, the company could earn about $0.70 per share, as the results are largely in line with expectations, but now shares have fallen significantly. Trading at $22, the valuation has fallen to still an elevated 30 times earnings. So basically, if we compare the situation versus this time past year, we see shares being cut in half, and earnings per share largely flat compared to the year before, as the move lower in the share price itself cut the multiple from 60 to 30 times earnings here.

Final Thoughts

Truth be told is that a massive pullback is always an interesting case, certainly as the business is inherently strong and benefits from long term secular tailwinds. Shares are down more than half from a high around $50 last year to just $22 at the moment of writing, but as discussed above it still works down to a premium valuation at around 30 times earnings here.

Besides the high valuation, investors are fearful about a combination of higher interest rates having an impact on the housing market and related spending, as well as concerns about consumer confidence amidst raging inflation. The secular tailwinds should prevail in the long run, as it includes a focus on recycling/ESG practices, low maintenance of its products, and quite frankly some sizeable insider buys as of recent.

Last week I covered peer Trex (TREX) as it too surfaced on the 52-week low list, with its shares down more than 50% from the highs as well, as it too still trades at a premium forward multiple at around 25 times earnings, with a premium valuation attributed to the secular growth positioning, offset by concerns about the outlook here. Given the slightly less-demanding multiple of Trex, I favor that stock over AZEK right now, albeit that both stocks have seen a similar positioning and thesis.