The AZEK Company Inc. (AZEK) Earnings Call Transcript

Good morning, everybody. I'm Tim Wojs, and I cover building products here at Baird. And we're very happy to have the AZEK Company join us again this year at our Global Industrial Conference. For those of you who don't know, AZEK is a leading manufacturer of composite products. They have leading positions in decking, trim railing and pergola markets. And from the company, we have Jon Skelly, who's President and -- he's President of the Residential and Commercial business; and then we have Eric Robinson up here, who's VP of IR. I do want to highlight AZEK is currently in the quiet period. So our conversation today is going to focus on bigger picture topics about the business and the company's strategy. So we're going to start with some slides from Jon, and then we'll do a little Q&A up here after that. So Jon, the floor is yours. .

Thanks for having us, Tim. So I'll quickly just do a brief overview of the business, keep it quick and talk to you a little bit about some of the new product introductions we're bringing to the market, and then we'll do some Q&A. So AZEK Company, our core brands are TimberTech and AZEK Exteriors. We are market leaders in the deck, rail and accessories as well as PVC Exteriors. If you look at that home, the siding, the turn around the windows, the decking, the railing, all that we manufacture, we're vertically integrated manufacturer of building products. So a pretty long track record here. We have built the brands over 20-plus years, company just under $1.5 billion top line net sales. Close to 70% of the business is decking. The other 1/3 is exteriors, and then we have a small commercial division. Business, consistent double-digit growth across the business, a 10-year CAGR of about 12%. What makes us special, again, is that vertically integrated manufacturing, very strong downstream sales and marketing of the market-leading brands. We have the biggest and best distribution relationships across the United States. We partner -- we sort of built the business as a Pro brand. We're partnered with all the best professional dealers. That's where our contractors prefer to buy from as well as an expanding retail presence. Another really important part of us is the stickiness of our customers. We have over 15,000 loyal contractors who install our products every day. One of the things that's a little bit more unique about us is we play in the entire outdoor living space. So you can see some of the pictures here, decking, railing, exteriors and pergolas. Anything that you want to beautify the outside of the home with our key themes of high beauty, low maintenance and sustainability, right? So we use a lot of recycled plastics and aluminum in our products. They're going to look beautiful. They're going to have very long warranties. They're going to have very low maintenance. So this allows you to convert materials. We'll talk more about this away from things that fail a lot like wood to much longer-lasting sustainable, beautiful products. Our market opportunity is substantial, about close to $25 billion in total. Our kind of core deck, rail and Exteriors business, about a $14 billion opportunity. We've expanded into close adjacencies such as siding and pergolas that we mentioned. Again, we have a very strong opportunity and growing opportunity in terms of our TAM. That's another thing that makes us a little unique, a larger addressable market. You can see some of the sizes there in terms of a $5 billion decking market, $4 billion exteriors. The other thing that's really important in terms of where repair and remodel investment dollars are going, they're predominantly going outside of the home. Over a very long period of time for the last 5 to 10 years, the most popular area of repair and remodel investment is outside the home. And again, what's unique is the ability to take something that's failing, we're solving a business problem here. So this is actually my deck. So that the picture on the left was my deck 4 years ago. The picture on the right is my deck today. So I'm a perfect case study of what wood conversion means and what it looks like. That picture on the left, I hate to say it was only 5 years old. That's a 5-year-old wood deck. Yes, I never stained it. I never sanded it, and that's what you get. On the right, looks just like that 3 years in, and that's what consumers are buying, is they want the beauty, they want the low maintenance, they don't want to have the ongoing life cycle costs trying to manage the upgrade. And it's been accelerating, right? So one of the most important parts of our business, one of the key tailwinds is this wood conversion. You can see that it was moving along at about 50 bps from '14 to '18. You've seen an acceleration to over 100 basis points of change. And a lot of that is really just around education and awareness. So as we improve the technology of the products, they look better, they're longer lasting, and then we're really driving awareness, right? We want more and more consumers to touch and feel our products and to understand that maybe 10 years ago, Generation 1 of a composite product, you might look at it and say, "that doesn't look quite like wood, might look a little plasticy." With the technology today, there's no compromises, right? You get the low maintenance, you get the long warranty and you get the beauty of real wood, and you don't have to get on your hands and knees and sand and stain it or pay somebody else to do it, right? So as we improve the technology, as we increase the awareness of the category, that's what drives the acceleration of conversion. We believe we'll get to 50% in the next 10 to 15 years, and there's no reason we can't be at 75%. If you look at other areas outside the home as a proxy, such as siding, which we obviously attached to and which we're now in the business of, siding is about 75% plus composite, almost 80% plus composite, very little wood, right? You actually have to look really hard if you want to try to add a wood door to your home, they're hard to find now. Most of those have converted to composite, right? So if you look outside the home, you'll see most has converted. We're still 75% of decks built every year are built out of wood. So we see that massive conversion opportunity going forward. Our strategy is pretty simple. First and foremost, capitalize on that market conversion, right? Everything that we can do to continue to drive awareness, continue to drive acceleration of the market from wood to our types of materials. We do that through product innovation. We are the market leader every year. We're introducing new products that are solving customer problems and improving the beauty that we're able to bring outside of the home. We'll talk a little bit about some of the new products that we just brought to market this year in a moment. Multichannel expansion, that's just continuing to expand our business model into new areas, continuing to expand in the Pro channel. We've been expanding in the retail channel. We've been expanding geographically. The consumer journey is an area where we've been investing and we're going to continue to invest against. This one is important, right? So from the moment you're at a friend's house at a barbecue and you're standing on their beautiful TimberTech deck, you say, "All right, I'm in, I want this." From that day forward, it can be long. It can take anywhere from 6 to 18 months. You have to find the right contractor, you have to select the material. You have to do -- get the product installed correctly. We see a massive opportunity to improve that experience, shorten that experience, and increase the close rate of an individual who's starting to be inspired to actually having their deck built and installed. That's going to be an area where we're going to continue to invest and make it easy for anyone like you to beautify the outside of your home. And then strategic M&A, again, nothing transformational here, but we have a consistent history of doing unique bolt-on transactions where we can leverage our purchasing, we can leverage our channel, we can leverage our brand. We can leverage that really sticky customer base of contractors who now can go to a homeowner and instead of just selling them the deck, they can sell them the deck, they can sell them the rail, they can sell them the pergola and drive a higher rate of material conversion all around the home. And it's been successful. So we've had a really nice run. I joined the business in 2017. We've come close to tripling the business, right? So it's a really high-growth business, 16% CAGR within the residential business and an even faster growth of earnings. So we're getting earnings leverage on top of the strong double-digit growth that we've been driving in the business. And so how do we get there? This is a simple growth stack, right? We've talked about this before. Again, repair and remodel is the core driver of our business. It's roughly about 85% of our business is correlated to R&R. Consistently, that's been a very stable and strong part of the marketplace. That 4% that you see there, that's sort of whether it's a 5-, 10-, 25-year CAGR you look at in terms of R&R, you have that base growth rate that you're starting with. And we've been -- it's been soft the last couple of years. The R&R market has actually been down, but our outlook for R&R is to return to that consistent stable growth in the marketplace. On top of that is where we add material conversion, right? And so if the R&R market is growing at 4% as we convert wood to our type of materials, you get an additional 3% to 4% of growth on top of that, right? So in a normalized year with steady R&R and steady conversion, we have a 7% to 8% sort of market growth rate for this business, which is really powerful. Then on top of that, we execute -- what we execute. Well, I should say that conversion, we're helping drive that. we don't wake up and just the market converts. The things that we're talking about earlier in terms of awareness, education, downstream sales, that's helping drive that conversion. That's not just happening by chance, ourselves in the market are pushing that conversion. On top of that, we have our growth initiatives, right? These are the things our proven execution, our proven capabilities to grow this business faster than the overall market. Product innovation, multichannel expansion, customer journey. Those are those kind of growth drivers, proven growth drivers that we talked about. That gives us an opportunity to drive an additional 200 to 300 basis points of growth. And so again, our target here, we believe we can grow this business consistently at a double digit, and our history showed you in the last slide that we've been able to achieve that. So we talk about innovation, we talk about products. Again, every year, we're going to bring new products to bear. So here are 4 new products that we just launched this year, a premium vinyl railing, a new steel railing. We've launched an additional line within our premium PVC decking. And then we've launched TrimLogic, which is a sub-premium trim. The story here is pretty simple. If you look at our business as a whole, AZEK Exteriors and TimberTech decking, we sort of started as the premium player. We produced the most beautiful, the best visuals and built a sort of premium brand in the marketplace over the last 10 to 20 years. Then what we've done over the last 5 years is we've really produced a sort of good, better, best premium portfolio in decking, right? So we are able to meet the consumer at any price point. We believe we provide the best value and the best visuals at each price point, but we've done a nice job of diversifying the decking business to be able to service the various price points across the business, and what we've been able to do there is create very balanced growth. If you look at our portfolio in decking, we see growth across all price points within that. But if you looked at exteriors, we were still just a premium player. We sort of offered our classic white trim. We also offered a similar premium paintable trim. But we didn't have a similar kind of good, better, best offering in that portfolio. Now we do. With TrimLogic, it is a very high recycled must be painted product, but it's something that's going to have a more aggressive price point versus the classic. And so now we're going to have sort of a better and best offering there. Same thing within railing. As you look at wood conversion, we have a terrific premium composite rail, a very fast-growing aluminum rail. But again, if we want to meet people at a more entry level, vinyl and steel is the product that you typically see in the more entry-level kind of good, better category. So now with the launch of our vinyl railing and steel railing, we now have a good, better, best premium offering in railing. So it's proven it. We know we can do it. We've executed it in decking. Now we're going to be able to execute it in exteriors and railing. So we're really excited about this innovation and these new products. Again, we showed you the chart, we've been able to improve our gross margins and EBITDA margins while we've been growing the business at double digit. We have a target of 27.5% in 2027. We reviewed that at our Investor Day a couple of years ago. We're slightly ahead of schedule there and continuing to drive margin improvement. And then from a capital perspective, you're always going to invest first in the business. It's a very high-return business. So we're going to start by putting dollars into the business, things such as our Boise expansion, which allowed us to have manufacturing closer to the customer out on the West Coast. Second is going to be M&A. Again, strong track record, mostly bolt-ons and then share repurchases beyond that. So that's the story.

Great. Great. Thank you for doing all that. That's great. Maybe just talk a little bit about -- and I think one of the things that maybe gets underappreciated by investors is when Jesse came and you came, I mean, just the business was in a different spot than it is today. And so could you just talk about a lot of the investments that you've made over the last 5 or 6 years in terms of salespeople, in terms of distribution, in terms of product, in terms of capacity just because I think the business today is way different than it was 10 years ago, and sometimes that kind of flies under the radar.

Sure. Great. Yes. So I mean, again, I think we started with a really good company and the management team has been really working to make it a great company. So it started with the right vision, values out of the gate, sort of resetting our culture and who we are and how we wanted to show up. And a lot of that is driving really good execution, get the right people on the bus, point them in the right strategic direction and then go execute. So we've been doing that. And it really started with the first thing we said is let's go into the plants and make sure we have the right capacity. We have -- we're strong believers in this market opportunity, the conversion opportunity. And if things progress the way we think they're going to progress, we're going to need more capacity. So we started operationally making sure that we had great performance out of the plants and then we started to expand, invest significant capital to be able to drive future growth in the business and capacity, which we did. Once we started to have our operations stable and more investment in capacity, we reignited the innovation engine, right? And so that was really getting back to regular annual new product introductions that expanded our total addressable market, right? So I talked a little bit earlier about taking that premium position that the company had developed and expanding in decking to have good, better, best offerings. We're now expanding into other categories to do the same thing. So we were broadening the portfolio while we were increasing our investment in the technology, the visuals, the long-lasting durability of the product. So really driving a repeatable product innovation engine, and that's served us really well, right? That's really allowed us to -- when we talk about shelf space gains, not only have we entered new customers, but we've expanded our positions on the shelf at the customers with that broadened portfolio. Sales and marketing is something that we think we're unique. We have a couple of hundred salespeople now out on the street. That's from less than 100 a few years ago. And we've also meaningfully expanded our marketing investments to drive our brand awareness and our stickiness with consumers, right? And so that is an engine that we'll continue to invest. At the same time, we were investing there. As Tim mentioned, we were broadening our distribution base, right, our distribution partners who they take our product from our factory and get it close to the customer. We've also been working with them on improving their demand generation to where they primarily help us from the dealer level. They're really calling on that dealer once we gain those positions and making sure that dealers have the right products in stock, that they're knowledgeable about the products, and they're able to provide great service for the contractors that purchase from them. So a lot of investment there. And then we've been investing in technology and systems, digital, multiple other areas. So right, we knew when we joined the company that we had a good business so we could turn into great. We also made a lot of investments to be a very sustainable public company. Again, that's accounting resources, finance, all those various capabilities you need to be a public company. So a lot of work, but a lot of fun, and we're seeing the payoff in terms of a lot of those investments.

Good. Good. So historically, you guys have been really strong in the wholesale channel, and you haven't had as much presence at retail. But over the last 2 years, I mean, you guys have picked up shelf space at retail. So I guess what's the change either internally or externally? And what's really driving that ability to kind of take on more retail business?

Sure. So I think maybe one thing that might not be as well understood about the businesses, while we haven't had much of a stocking position, we have had a growing and successful special order business. And for most of you that are involved in businesses with retail presences, you tend to see much better margins and performance of your special order business than you do your stock business. And I think it was just a part of the kind of strategic and cultural reset we talked about, Tim, where we decided that, that is a place -- that is a market where we're underpenetrated and we see the opportunity. And namely, it's -- we think that there's a lot of wood conversion that we can drive within the retail channel, right? There tends to be -- a lot of the professional contractors we do with the individuals who are going to come to your home and install a $100,000 deck they're not installing wood. They're already fully converted to premium PVC and composite decking. When you look at a lot of the kind of transactional handyman or what we call kind of 2 and 10 contractors, they build 2 to 10 decks a year. They might do a siding project. They might work on your kitchen, right? They're just kind of general contractors. You see a sort of a steady stream of those professionals buying from these retail outlets. So as we try to drive wood conversion, if you're able to get -- have a relationship either through special order and through stocking where you're present at those, you're able to capture more of that transactional business, and we're able in the aisle at a place like Depot or Lowe's to tell the story about wood conversion and why we should convert from pressure-treated lumber up to a composite, right? So that was an area, Tim, where we think we can really drive wood conversion. And so that sort of led to us saying, "hey, this is a place where we need to invest more." And again, it's -- we're just going to continue. We're -- it's not a place where we're trying to hit home runs. It's a place where we want to just consistently continue to gain share, and we've been successful doing that in the last few years.

Okay. Okay. Great. Just on conversion. So you guys are at -- or the industry is at 25% conversion today, still like a lot of wood decks. And so I guess what type of -- I don't know if it's data or surveys or customer research that you've done that gives you the confidence that, that penetration can get to 50% or that penetration can get to 75%. Just because like every year, it just seems like more and more and more of the benefits of composite kind of get a little bit more ingrained in the consumer's mind.

Sure. Certainly, we do the surveys at the contractor level, at the dealer level every quarter. We're capturing the data, and that's what gives us confidence, right? We sort of ask on a year-over-year basis, how many wood versus composite decks did you install this year versus last year, right? So we're capturing that data and understanding at a more micro level, what some of those conversion statistics look like. When we're -- we look at the samples that we're delivering to consumers, we look at the number of website visits, we look at the number of leads we're providing contractors, you're seeing growth and growth and growth, right? So what that is, is we have more engagement with more consumers and more contractors around our products, so we're providing that education. We're providing that awareness, and we're seeing the data that says, okay, each year, that continues to progress, right? So between the survey data, our internal data and then, again, a lot of just whether it's Depot Lowe's, Pros, you're seeing an expansion of what's being put on the shelf for composites versus wood, right? You're not walking into a lot of prolumber yards and saying, "Hey, I just kicked out composites and put a whole new wood aisle," you're seeing the opposite where I just took some of that pressure treated out and I put more in. I took some of that cedar redwood out and I put in more premium composite decking. So those are the data and the trends that we're looking at that give us confidence that you're starting to see this conversion.

Okay. How important is railing to the business? Because I think historically, your attachment rate or just the industry's attachment rate from composite deck boards to railing has been miles different. So is that something that internally you're focused more on kind of tying together? Or is it still kind of product by product in terms of how you think about the railing business?