Trex Earnings Preview: Key Things to Watch

By Markets Fool.com


Source: Trex Company.

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When premium recycled decking makerTrex last reported earnings, it exceeded not onlyanalyst expectations, but also the company's own guidance for both revenue and earnings per share. With earnings for the fourth quarter scheduled for Feb. 24, what should investors expect? Let's take a closer look at a handful of key things management has been focusing on.

Growth is moderating after full year of new U.S. distributors
It's hard to believe that it's already been a full year since Trex announced it had expanded its distributor base, adding a large reseller in the Northeast last year with substantial market share. Even in a weak environment for the kind of high-ticket home improvement products Trex sells, the company has reported almost 14% sales growth so far this year. The third quarter was especially strong, with sales growth of better than 32%, and $8.9 million in net income after a loss in the same period in 2013.

Guidance for the fourth quarter is for sales to grow around 10%. While this is a far cry from last quarter's blowout, it would still be a strong showing, based on the market conditions. As I wrote in myTile Shop Holdingsearnings review, existing home sales are a major source of demand for these companies, and they remain well below historical sales rates. Until the housing market returns to higher levels, it will be harder for these companies to grow, outside of expanded distribution and taking market share.

Focus is on cost containment, expanded product mix
On last quarter's earnings call, Trex CEO Ron Kaplan said, "On a cost reduction side, in Q3 we began to realize the benefits from three cost reduction initiatives. The full impact will be realized in Q4." The company's cost-reduction initiatives have been process-related, and not based on capital investments, so investors shouldn't expect to see any impact on capital expense due to the completion of these cost-reduction initiatives. Furthermore, the fourth quarter is the slowest period of the year, so the full impact in that quarter may not really indicate what the full benefit will be during periods of higher production, such as the first and second quarters of the year.

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Trex decking in a four-mile boardwalk in Dubai, connecting six communities. Source: Trex.

However, Kaplan also confirmed that they were seeing what looked like a building season carry later into the year, so it's possible that some of this late demand carried over into Q4.Part of this could be due to the company's expanded mix, including metal lighting and railing products that can be used in non-Trex decks.

Lastly, the company's new poly pellet business isn't expected to add materially to the company's results in the fourth quarter, or significantly in the first half of 2015, as far as that goes. Management expects this new business to be worth $50 million to $70 million by 2017, but the initial ramp-up in 2015 is likely to net between $10 million and $20 million in incremental sales.

Long-term success will be driven by product innovation, cost-containment, and eventual rebound in existing home sales
Even after a very strong 2014, Trex investors need to remember that the operating environment remains relatively poor, with housing sales still well below historical rates. However, the U.S. economy continues to strengthen, and there has been some evidence that falling unemployment -- which is now solidly below pre-recession levels -- is helping drive wages up. If this turns into a sustained trend, it could very well lead to a tailwind for the entire home improvement industry.

Since taking control in 2008, the current management team has measurably improved the company's financials by almost every measure:


Source: Trex Company investor presentation.

Until the eventual bounce-back in housing -- which could happen sooner rather than later with a strengthening economy -- investors will continue to own the best operator in this segment. When home sales do recover, the returns could be well worth the wait.

The article Trex Earnings Preview: Key Things to Watch originally appeared on Fool.com.

Jason Hall owns shares of Tile Shop Holdings and Trex. The Motley Fool recommends and owns shares of Tile Shop Holdings and Trex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.