Azek: Strong Brand, Network Of Partners In A Growing Industry

Investment thesis

I believe AZEK Co. (NYSE:AZEK) is undervalued. I expect outdoor living industry to see continued growth as more people spend time outdoors, and AZEK’s products, particularly its decking product, offer a compelling value proposition with their low maintenance, attractive appearance, and lower lifetime costs compared to traditional wood products. AZEK strong brand reputation and a portfolio of premium brands, as well as a vertically-integrated model and expertise in materials engineering well-position it to benefit from these trends.

Business overview

AZEK is a company that produces furnishings for use in the great outdoors. Decks, railings, trim, and accessories are all things that the company produces.

Outdoor Living Industry to grow as more homeowners spend time outdoors

Numerous sizable and promising markets find value in AZEK products; these include both residential and commercial applications, while the Outdoor Living sector is where the company’s primary attention lies. I expect the Outdoor Living sector to continue to see significant investment as more and more people make the choice to spend time outside as a form of recreation.

AZEK and similar low-maintenance, manufactured alternatives are becoming increasingly popular in the outdoor living industry. In 2016, wood accounted for more than 65% of all linear feet sold in the U.S. deck, rail, and trim industries, but by 2019, that number had grown to roughly 78%, suggesting a rapid growth in the conversion rate away from wood. AZEK’s market-leading size, vertically-integrated business strategy, and materials engineering expertise put it in a prime position to take advantage of the growth prospects in these industries over the coming years.

AZEK’s Decking product has many opportunities to grow

AZEK’s biggest product line is decking, which gives homeowners a great chance to increase their home’s usable square footage and put their own personal stamp on a place dedicated to leisure and socializing. Additionally, AZEK has substantial possibilities to grow into new submarkets of the Outdoor Living sector by capitalizing on its strengths in material science, brand recognition, and channel partnerships. In my opinion, the increased in-home activity that occurred during the COVID-19 pandemic could provide as a further impetus for more homes to see the value in the AZEK Outdoor Living product line.

The TimberTech EDGE Prime decking from AZEK is just one example of how the company’s products can outperform more conventional wood decking in terms of durability, dependability, aesthetics, and cost over time. Management at AZEK has calculated that over the course of the 25-year warranty period, the total lifecycle cost of TimberTech EDGE Prime decking is roughly 37% less than that of a comparable pressure treated lumber deck. Additionally, replacing standard deck boards with AZEK product while making use of an already established and well-maintained substructure allows consumers to efficiently convert to a long-lasting, low-maintenance materials at around the same cost as TimberTech EDGE Prime decking goods.

On the other hand, thanks to its high quality, composite decking has been rapidly expanding its market share. As people become more educated about the need of using eco-friendly products and as technological advancements in the manufacturing sector allow for a wider variety of color and texture options, I think the market for composite products will continue to rise. Nonetheless, this does not imply a decline in AZEK’s market share. In order to make composite products more accessible and increase their lifetime value benefits, AZEK provides products that lessen the price gap between composites and traditional materials. As a whole, I believe AZEK’s products are set up to succeed regardless of the economic climate, due to the vast opportunities available to increase penetration and cost advantage.

AZEK has a portfolio of premium brands

AZEK has been known as a premium brand thanks to its dedication to innovating cutting-edge new goods that incorporate cutting-edge design and innovative designs with specialized knowledge in the field of material science and exclusive manufacturing techniques. In addition, they have put a lot of effort into direct sales and customer service, which has resulted in widespread recognition and devotion to their brand among distributors, home remodeling retailers, and builders. Recently, AZEK has made considerable efforts to strengthen and enhance its brands by introducing new products with improved looks, launching novel go-to-market initiatives, and increasing its online presence. Thanks in large part to these efforts, AZEK is now widely regarded as one the top brands in its industry.

Extensive network across the value chain

Over its nearly four decades in business, AZEK has developed a large group of dedicated builders, distributors, and dealers in the United States and Canada. I think AZEK has fostered such confidence and reliability within their dealer and contractor networks because of their consistently high standards of product development, craftsmanship, and effectiveness, all of which have a trickle-down effect on the company’s bottom line via increased sales to end-users (i.e., a better product by AZEK will boost their reputation and increase end-consumer purchase frequency).

Given the widespread familiarity with AZEK product and its ability to connect with consumers directly to spur conversion, I think AZEK makes a great business partner. Because of this tandem, I expect AZEK products to remain a top investment for these partners for the foreseeable future.

Vertically integrated model provide cost advantage

AZEK is an efficient company with a streamlined production process. AZEK has expanded its manufacturing operations to various locations, and the company has made substantial investments in personnel, infrastructure, and procedures to boost output. AZEK’s capacity to incorporate more recycled content in its product offering, thereby reducing dependency on more expensive alternatives, is, in my opinion, the company’s most significant cost advantage.

Valuation

Based on secular trends mentioned in my thesis and historical growth, I believe AZEK can continue to grow over the long term, albeit a slowdown in FY23 due to a bad economy

My model suggests AZEK could be worth 28% more than its share price today if multiples are to remain the same in FY24. I believe this is likely to happen as FY24 is where I expect AZEK to see growth reaccelerate to a positive.

Model walkthrough:

1. Revenue is expected to grow back to historical rates ~10+%, but will face a slowdown in FY23 due to bad macro-economics.
2. Margins to revert to historical levels gradually
3. AZEK to trade at the same earnings multiple in FY24

Risks

Cost inflation

Composites rely on resins and other common materials for their construction. The company’s financial results could take a hit if the cost of these inputs unexpectedly increases and it is unable to compensate for the increase through price increases or other means.

Execution risk

The company’s performance in expanding its operations, ramping up its additional capacity, lowering its expenses, and increasing its manufacturing efficiencies throughout its sectors and product categories is crucial to my projections. It’s possible that results will suffer if these initiatives’ completion time is prolonged or if management is unable to completely implement its plan.

Conclusion

I expect the outdoor living industry to see continued growth as more people spend time outdoors. AZEK is well-positioned to reap the rewards of these shifts thanks to the company’s formidable brand reputation, portfolio of premium brands, vertically-integrated business model, and knowledge of materials engineering.