The AZEK Company Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

The AZEK Company Inc. is a manufacturer of high-performance, low-maintenance building and outdoor living products made from recycled materials, primarily focusing on the residential and commercial sectors.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

AZEK operates in two main segments: Residential and Commercial. The Residential segment focuses on outdoor living products such as decking, railings, and trim, predominantly targeting homeowners and contractors. The Commercial segment caters to large-scale infrastructure, architectural, and design projects with products like polymer sheet, cladding, and specialty building components.

  • Revenues by segment: In 2022, the Residential segment generated approximately $1.14 billion while the Commercial segment generated $585.1 million.
  • Geographic Presence: AZEK is primarily a U.S. based company with some sales in international markets. The majority of their business comes from the U.S, particularly the residential market. However, in recent years, they are also pushing to increase sales in commercial applications, like building materials and infrastructure, and European markets.
  • Customer Base: The primary customers of AZEK are builders and contractors for residential and commercial projects, as well as some direct retail sales.

Industry Trends:

The building materials industry is highly competitive and fragmented with thousands of different suppliers. However, the demand is generally influenced by macroeconomic factors such as new construction rates, interest rates, home-remodeling activity and is closely tied to the economic cycle. Additionally, there is a growing emphasis on sustainable building materials due to environment concerns, and there is a trend towards low maintenance materials and durable products. Also, with the internet and social media becoming the new way of marketing and reaching consumers, digital distribution is becoming more important for the company and is starting to take precedence.

  • A trend toward sustainable building practices and recycled materials.
  • Increasing preference for low-maintenance and durable products.
  • Shift to online channels for product discovery and sales.
  • Macroeconomic influences including inflation, housing market trends, and interest rates.

Competitive Landscape:

The competitive landscape includes traditional building materials manufacturers, commodity suppliers, and specialty product makers. The main competitors for AZEK are TREX, Westlake Royal, Boise Cascade, and Builders Firstsource. AZEK has been working on increasing their brand name recognition through various methods, including advertising and engaging with more customers and contractors. There has been an increase in advertising by other players in the markets to compete as well and the industry is trying to become more fragmented. For a competitive market, price and performance play a major role in customers buying decision and the company also need to focus on providing a value proposition to customers to gain more brand loyalty. Also, distribution is also a key factor in the industry.

  • Intense competition from traditional building material providers. * Increasing competition among other specialty building materials firms. * Price and performance are important to customers. * Distribution network is a must for companies to have. * Brand recognition and marketing is a necessity to increase sales. * Product quality and warranties also attract customers.

Moat Analysis (2/5): Assessing AZEK’s competitive advantages reveals a rather limited moat (2/5):

  • Intangible Assets: While AZEK benefits from brand recognition within the construction sector, it isn’t a ubiquitous brand name with an immense customer preference like some consumer goods companies. Additionally, there aren’t any patent or regulatory advantages. There is some emphasis on warranties but they have not been the key advantage.
  • Switching Costs: Once a construction project specifies AZEK products, swapping out becomes troublesome and costly. However, it is still easy for contractors and homeowners to switch between AZEK and its competitors on new projects, so this isn’t a significant source of moat.
  • Network Effects: There are no network effects for AZEK.
  • Cost Advantages: AZEK benefits from using recycled material, and has vertical integration of their manufacturing which would lead to lower costs. Also, as a bigger player they could gain from economies of scale, but this advantage is very small. Given these aspects, there is some evidence of a cost advantage that could create a narrow moat, but is not a definitive edge for the company.
    • Rating Justification: The company possess some structural advantages, but their limited sustainability, along with intense competition, restricts the moat.

Risks and Resilience:

  • Economic Sensitivity: As it is a building material company, AZEK’s revenue will be strongly influenced by the macroeconomic factors such as new construction rates, interest rates, and remodelling and therefore could be a risk.
  • Intensifying Competition: Competition from other similar companies, will require constant innovation, expansion, and brand recognition to continue.
  • Raw Material Costs: Since AZEK is dependent on raw material for the manufacturing, it is exposed to fluctuating raw material prices, that will affect margins significantly.
  • Technological Disruption: AZEK faces technological disruption from new materials or alternative building methods, though it is likely that the company will be able to benefit from such disruptions due to its specialization in composite materials.
  • Limited Resilience: AZEK is heavily tied to specific markets and demand, its current moat is not strong enough to provide the company to have resilience from competitors, therefore, if the market conditions turn sour, they will have limited options to maneuver.

Financials Analysis:

AZEK has had impressive growth in recent years, fueled by acquisitions, increased sales and market share.

  • Revenue Growth: The company has seen substantial growth in revenues, increasing by over 18.7% from 2021 to 2022.
  • Margins: While overall gross margins have been stable, fluctuations have appeared in different segments. Also, they have experienced margin compressions in the recent few quarters due to rising interest rates, cost of materials and increased operating expenses.
  • Profitability: Net profit margins are good and stable but are volatile, as evidenced by a big spike in 2021, with volatility in subsequent years.
  • Debt Management: The company has a substantial amount of debt, which is mainly variable. Also, the company has taken up debt to finance new acquisitions, which has increased debt by over 20% in the last 3 years. Interest expenses have also seen a significant increase. The company has also increased its debt repayment period from 5 years to 10 years which provides some much needed flexibility.

  • Financial Metrics: AZEK’s latest metrics show a growing company but financial debt levels are a matter of concern. Also, even though they are earning significant profits, that isn’t getting translated to high cash flows, which should be improved.

  • Capital Spending: The company has seen substantial increases in capital expenditure, as is required in a growing business, which will affect their free cash flows.
    • Historical Trends: Historically, AZEK’s revenues and profits have been on an upward trajectory. However, it can be assumed that there will be fluctuations in the long-term due to the nature of the industry, business cycle and macroeconomy.

Understandability Rating (2/5):

The company’s operations are relatively straightforward, but some of their practices are hard to understand, making it relatively difficult to understand for most people (2/5):

  • The different types of materials and engineering that go into making AZEK products are fairly simple.
  • However, the financial statements are complex and include a lot of moving parts like multiple subsidiaries, different business segments, goodwill and amortization expenses. It takes some time to understand the intricacies of the financials.
  • The effects of foreign exchange and currency fluctuations also complicate the valuations, but they are mentioned explicitly and are easy to comprehend.
  • They do not give any long-term projections or give guidance about performance metrics and the management is not very clear about it in earnings calls, and therefore it is difficult to understand management’s long-term vision.

Balance Sheet Health Rating (3/5):

AZEK’s balance sheet has aspects that are both healthy and unhealthy (3/5).

  • Strengths: AZEK has shown good growth in revenues and assets.
  • Weaknesses: The increase in debt levels and interest expenses are concerning, given the volatile market. The current liabilities are almost comparable to the current assets, which is worrying for liquidity, but they do have a good level of working capital.
  • Overall: AZEK has some stability but is not exceptionally well, and they could be better in management of debt and leverage.

Recent Concerns / Controversies:

  • Guidance Concerns: In Q1 2023, the company lowered its net sales guidance to $1.46 billion-$1.54 billion. They blamed the lower guidance on persistent high interest rates and a decline in demand for building materials and general economic conditions, which could potentially impact long term revenue and profitability.
  • Margin Compression: AZEK has experienced margin compression due to rising raw material costs and operating expenses, which affects profitability and cash flow, which was a primary concern among analysts during Q1-Q2 2023 calls. Also, the company’s management has acknowledged the current pressure on margins due to inflation and higher operational costs.
  • Debt Increase: The company’s debt levels have increased substantially, which in turn has increased debt servicing costs as the interest rates have risen over the last few quarters.
  • Acquisition Risks: Acquisitions could pose integration and execution risk, as integrating new businesses often requires time and might not provide the synergies management expects.