Trex (TREX -0.93%) investors know a thing or two about flooring. And we're not just talking about its eco-friendly composite decking materials. Trex stock is closing in on the two-year lows it hit less than two weeks ago after the company posted disappointing financial results this week.
Monday afternoon's report wasn't as smooth as its signature outdoor flooring that holds up better to the elements than the wood planks it tries to resemble. Net sales plummeted 44% from the prior year's third quarter, a stunning reversal for a niche leader that had rattled off 10 consecutive years of 9% top-line growth or better. Is this the end of a decade of monster growth for Trex, or can it weather the storm like its product?
Let's take a closer look at the slide. It's not as surprising as you think when you consider the business and its market.
Image source: Trex.
Hit the deck
A year ago -- some would argue even a few months ago -- the housing market was booming. Folks were buying new homes, and interest rates were low. Buying a new home and/or expanding one's outdoor living space made investing in a Trex project an easy sell for homeowners. And the trend also made Trex an even easier buy for investors. A $10,000 investment in Trex a decade ago at the start of its positive net sales run would be worth nearly $115,000 today.
It's a patio pity party now. Rising mortgage rates make financing a Trex buildout an even more expensive proposition than before, and don't even think about a cash-out refi to tap into your home equity for support. We already mentioned the high rates, but as home values are likely to drop in the coming months, it's going to give homeowners less equity to leverage for home-improvement adventures.
Before Monday afternoon's report, Trex had come through with 12 quarters of positive year-over-year growth in net sales. All but one of those dozen reports wasn't a double-digit increase. Its most recent entry before this week was solid looking back, as net sales and earnings per share climbed 24% and 49%, respectively, in its second quarter. However, it did point out in that early August report that business was coming to a screeching halt.
The bottom of its business started to fall out in late June, as it began to see a sudden reaction in demand from its retailing partners. Consumer interest in decking thinned out, and that meant that home improvement chains had an excess of inventory to clear out before ordering again. Trex braced investors for a sharp reduction in net sales for the second half of the year. Trex said at the time that it would maintain its competitive cost structure through "production and labor force optimization," which basically means it would be slowing production and letting some of its employees go.
Its guidance called for $185 million to $195 million in revenue, and it landed just below the midpoint. It didn't provide a net income forecast, but with its outlook for EBITDA margin of 27% to 29% for all of 2022 -- after topping 32% through the first half of this year -- it was clear that the bottom line would be taking an even bigger hit than the top line. A Trex profit of $0.14 a share excluding severance charges landed exactly where analysts were perched.
There were no surprises in this week's outlook. It reaffirmed its guidance calling for $180 million to $190 million in net sales for the fourth quarter. It also sees its EBITDA margin improving from 17% in the third quarter to between 22% and 25% in the fourth. It continues to expect that EBITDA margin to be between 27% and 29% in 2022.
Trex continues to eat its own cooking, shelling out $100 million in repurchasing another 1.7 million shares. It isn't a good look for a company to buy back its stock as it heads lower, but it ultimately improves profitability on a per-share basis.
It may not be fashionable to warm up to Trex right now. Tailwinds including the housing boom and the suburbanization trend that delivered a 36% surge in net sales in 2021 -- its strongest growth in more than two decades -- are going the wrong way. There is still a strong case to be made for the inevitable return of growth for Trex. It's the undisputed market leader in its niche, and it doesn't take a lot of convincing to someone considering a decking project to go with the largely reclaimed wood and plastic film that Trex uses to avoid the annual laborious and costly maintenance required by traditional wood. When sentiment returns for housing stocks, Trex should lead the way just as it has in the past. If the stock bottoms out here, it will be one more thing investors know about flooring.
