The AZEK Company: An Analysis by Cristian Velasquez
One man’s trash is another man’s deck, moulding, trim, porch, siding, etc. Imagine a world where 30,000 plastic bags can be converted into 300 sq ft of beautiful, durable, and long-lasting decking. Where you no longer have to worry about the effects of mold or weather damage to your newly installed deck. This world is becoming a reality thanks to the efforts of The AZEK Company. A company who in 2020 recycled 400 million pounds of material¹.
The AZEK Company, one of 2020’s newest public companies, is a market leader in premium outdoor living products for both commercial and residential customers. In their June 2020 10Q report, AZEK wrote:
“We define the Outdoor Living market as the market for decks, rail, trim, wood and wood-look siding, porches, pavers, outdoor furniture, outdoor cabinetry and outdoor lighting designed to enhance the utility and improve the aesthetics of outdoor living spaces.”
The Product
The company focuses on manufacturing and selling outdoor products traditionally made out of natural resources such as wood and instead leverages its manufacturing facilities to build long-lasting, durable, and high-quality products almost fully made out of recycled material. Composite material. Composite materials are built to last. They are made from wood by-products and recycled plastic which all have the same goal:
“to obtain a higher degree of resistance to moisture, UV rays, staining, fading, and scratching. This new generation of decking products promises enhanced performance, wood-like realism and extremely low-maintenance requirements⁴.”
AZEK’s comprehensive product offerings are sold at various price points through their 4,200 dealers, 35-plus distributors, and multiple home improvement retailers².
The products are subject to seasonality and macroeconomic factors. In the northeast, sales for home exterior products are lower during the winter and tend to increase as the coming spring and summer months roll around, enticing AZEK to offer product discounts —
“We have typically experienced moderately higher levels of sales of our residential products in the second fiscal quarter of the year as a result of our “early buy” sales and extended payment terms typically available during the second fiscal quarter of the year. As a result of these extended payment terms, our accounts receivable have typically reached seasonal peaks at the end of the second fiscal quarter of the year, and our net cash provided by operating activities has typically been lower in the second fiscal quarter relative to other quarters.²”
Areas such as the southeast, southwest, and western regions of the United States have a higher demand for decks and outdoor products due to more favorable weather conditions. Therefore, the need for maintenance and replacement becomes higher because of frequent usage. Other AZEK products such as bathroom partitions and lockers experience higher sales during the summer before school begins, a period when institutions typically do their construction and renovation activities.
The Structure
The AZEK Company is a holding company with four subsidiaries: AZEK Building Products, Versatex, Scranton Products, and Vycom. Each subsidiary has its own purpose and niche despite being within a similar industry. As a holding company, financial and legal risk are spread through their subsidiaries…in theory. Should one go bankrupt, the bank cannot claim the assets of AZEK’s other subsidiaries, making monetary losses isolated to one subsidiary. By being a holding company, you can own more for less. Although it is not clear from my research, AZEK theoretically could hold majority stakes in its subsidiaries but not have 100% ownership in them. As a result, they can own multiple subsidiaries and maintain majority control without having complete financial ownership, allowing them to own more for less. Another financial benefit involves their Revolving Credit Facility². AZEK was formerly known as CPG International LLC until it was acquired and rebranded as The AZEK Company. AZEK, directly and indirectly, holds all the financial responsibilities of the subsidiaries. By being a holding company, AZEK has been able to leverage the company to fund its acquisitions and continually invest in the business. Individual companies may not have extensive access to leverage because of credit risk, but a holding company can give its subsidiaries more access to funds should they need it.
AZEK Building Products can be broken into two divisions — TimberTech and AZEK Exteriors. AZEK Exteriors manufactures trim and moulding, while TimberTech focuses on premium capped polymer and capped composite decking along with railing, porch, lighting, and paver products⁵. The 2018 acquisition of Versatex gave AZEK access to a larger range of products for building envelopes⁶. AZEK Building Products offers contractors, homeowners, builders, architects, or direct sellers a wide breadth of products for any remodel, maintenance, or new construction job. A 2018 partnership with Ultralox increased its offering of fencing and railing products and leveraged Ultralox’s expertise in aluminum design and engineering⁸. As conversion from wood materials to composite materials continues to grow, AZEK will continue to compete to maintain its status as the best company for outdoor living products.
Vertical integration is a key strategy implemented by The AZEK Company. By acquiring companies such as Scranton Products, Vycom, and Return Polymers AZEK increased control of their raw materials which in turn decreased production costs for the company. Purchasing facilities where raw materials are converted into finished goods is not an unorthodox move for a company that emphasizes material knowledge and product development. Scranton Products and Vycom are two of the leading HDPE/PVC manufacturers — together they help construct bathroom partitions, lockers, and other commercial products that are designed to replace wood, metal, and other products⁵.
The Industry
AZEK primarily operates in the Decking & Patio Construction industry (although I will briefly mention other industries to let you better understand the bigger picture). COVID dropped the demand for this industry, but the outlook for Deck and Patio construction remains optimistic. 40 million decks in the United States are over 20 years old⁸. 40. Million. Decks. Read that one more time if you have to. The opportunity lies in material conversion. Many of these decks are beyond their useful life, no longer code compliant, or lack visual appeal.
“Successful product positioning can be achieved by stressing the importance of some attributes and developing a niche market for a product or group of products, increasing the market demand for the product⁸.”
AZEK must continue to change the perception of homeowners, the end-users of their products. In addition contractors, DIY users, and anyone else involved in the remodeling, maintenance, or new construction of outdoor living spaces must know the importance of material conversion. In comparing decks and patios, patios take 54% of the market, wooden decks are 36%, and composite decks were about 10% in 2020⁸. Despite lower market share, the composite deck market share will continue to increase compared to wooden decks based on factors such as durability, availability of designs, and rising prices for lumber. For a growing company in a growing industry, the opportunity will continue to present itself and it is AZEK’s job to capitalize.
The Pandemic
And now the topic we have all been waiting to hear about — COVID. COVID has affected every single industry. Some have felt it more than others, but each industry has been impacted. The housing industry and demand for AZEK’s products are correlated. Homeownership increased by 2.6 percentage points (total 67.4 percent) in 2020, and housing vacancies decreased by .5 percentage points (total .9 percent) in 2020 in comparison to this time last year⁹. The reason for this? Interest rates. The Fed’s response to COVID has been to lower interest rates. Lower interest rates entice people to continue to borrow and make purchases — including homes. Lower debt service costs have enticed businesses to continue to borrow and make investments despite tough economic conditions. In September of 2020, single-family housing starts to increase by 1.9%¹⁰. When you combine the increase in housing starts, decrease in housing vacancies, increase in homeownership rates, and record-low interest rates you have one major takeaway from this — opportunity.
The Opportunity
AZEK has a plethora of opportunities despite grave economic conditions but I’d like to examine a COVID silver lining. Refinanced homes. When the value of your property goes up and interest rates are lower, refinancing presents a tremendous opportunity for you as a homeowner to lower your mortgage payment AND take out extra money because of the increase in the value of your property. What you choose to do with that money is entirely up to you, but reinvestment of that money is a common practice. Why not reinvest that money into your home? AZEK mentions this in their June 2020 10 Q:
“…the residential repair and remodel market depends in part on home equity financing, and accordingly, the level of equity in homes will affect consumers’ ability to obtain a home equity line of credit and engage in renovations that would result in purchases of our products. Accordingly, a weakness in home prices may result in a decreased demand for our residential products.”
AZEK recognizes this market as a place for opportunity, so they must capitalize on the lower than average interest rates. Refinances are public records, which gives AZEK a tremendous opportunity to find potential leads.
The Financials
From a financial perspective, AZEK’s residential business represents an overwhelming majority of the company’s business compared to its commercial business. The residential business in the LTM ending in September 2020 was 94% of adjusted EBITDA and 86% of net sales, while the commercial business was 6% of adjusted EBITDA and 14% of net sales¹. In the Q4 investors call, CEO Jesse Singh announced a 30% growth in the residential business but a 14% decline in the commercial business. This is where being a holding company with multiple subsidiaries comes to its advantage. A 14% decline in the commercial business may not negatively impact AZEK Exteriors and Versatex as it could have if they were to be merged as one company. Despite an individual subsidiary being partially isolated from a decline in another, as a whole, The AZEK Company’s growth was partially offset by this decrease in the commercial business — a business that is highly correlated to macroeconomic trends. This is not to say that they did not have a lucrative year from a financial and operational perspective. For the financial year of 2020, AZEK experienced a laudable increase in sales of 18% and 30% for their exteriors and deck-rail businesses, respectively³. AZEK faces a challenge that they hope to combat with their recent $180M investment in manufacturing facilities — being unable to keep up with the demand for their decking and railing products³. The improvements and new construction of manufacturing facilities are expected to be completed in the next 15–21 months but until then, AZEK will face unmet demand potentially affecting future sales of their deck and railing business³.
As a company that manufactures its own products, variable costs will influence AZEK’s income statement. A 6.4 million decrease in EBITDA for the fiscal year of 2020 meant less production, decreased unit costs, and reductions in selling, general, and administrative expenses. Cost savings during times of low demand is imperative for a business such as AZEK. In a time when the macroeconomy is directly affecting their commercial business, they must have systems in place to moderate risk. An example of this would be their implementation of modular capacity in their manufacturing facilities. Modular capacity = cost savings. Modular capacity indicates having the correct amount of equipment necessary to meet the demand — no more, no less. The “shell” of the manufacturing plant is always there but the equipment needed will be flexible. Flexibility is a contributor to cost savings associated with this type of operational structure.
“Additional buildings and machinery are added only when new production capacity is required, thereby reducing initial investment outlays as well as financial risk¹¹.”
Large increases in CAPEX aren’t as necessary especially when demand can hit a trough as it did in 2020 because of COVID.
“What the industry would rather do is start with a modular fab, get it up and running quickly, using profits from the first module to fund additions,”
said Samuel Wood, one of the first people to conceptualize this type of production practice¹¹.
Risk
Despite being a company that is consistently experiencing growth and operational profit, AZEK must be able to withstand the possible threats that their business faces in the upcoming years. A close in state's borders, restrictions on travel and business activity, and mandatory quarantines could affect their ability to maintain their operations, support their customers, and find new business opportunities. Further restrictions could result in increased overhead expenses or other expenses related to COVID, leading to higher prices, increased demand for substitute products, or employee layoffs. Another risk the company faces is being overly dependent on its distributors and suppliers. 20% of AZEK’s net sales for the year ending September 30, 2019, were accounted for by Parksite Inc and almost all of the rest of the net sales were from their other top 10 distributors². An over-dependence on suppliers increases their bargaining power over AZEK, as stated in the 10 Q Report of June 2020;
“we rely on a single supplier for certain 77 critical capped compounds used in our deck and railing products….We are dependent upon the ability of our suppliers to consistently provide raw materials that meet our specifications, quality standards and other applicable criteria…”
This over-reliance on key suppliers and distributors could affect the quality and reputation of The AZEK Company. The AZEK Company must assure the capacity and quality of their suppliers grow in tandem with the demand for AZEK’s products, making this reliance on one supplier even riskier.
The final risk I will mention is AZEK’s financial risk.
“The credit agreements that govern the Senior Secured Credit Facilities contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interest²…”
As of September 30, 2020, total debt amounted to $467.7 million which is about one times net debt to EBITDA, less than the projected 2x to 3x adjusted EBITDA³. Their debt has left them strapped for cash as they have used money generated from sales and from their IPO to repay debt. Increasing leverage could continue to put the company at financial risk, but increasing leverage allows acquisitions and other investments into the business, should their hands not be too tied by their debt covenants.
Final Thoughts
Always do the right thing, everything starts and ends with the customer, every individual matters, lead through innovation, the best team wins, and better today than yesterday⁵— these are the core values of The AZEK Company. AZEK’s core values echo three factors that every business in the 21st century must focus on: sustainability, innovation, and customer satisfaction. By sticking to their core values, they have become one of the top companies in the Outdoor Living Space market. I believe AZEK will excel in the upcoming years and will become a market leader in the Outdoor Living market. With over 100 patents in commercial and residential business, they will continue to be a company that is focused on their customers, innovation, and sustainability⁵. The transition from wood products to composite material will continue to boom as homeowners continue to think about their environmental impact on the world. 80% of capped composite decking is recycled material and about 50% of PVC decking is recycled material as well — which means there is an opportunity for continued innovation for The AZEK Company¹. COVID will continue to be a fear in the minds of homeowners. As people go out less, they will spend more time at home and spend less on outdoor activities which can include travel and dining. With the money saved from leisure activities, people will look for other ways to spend their money, and what better way to spend your money than to spend it on the place you’ll spend a majority of your time at — at home. But this isn’t money spent, it is an investment into your net worth.
[1] AZEK December 2020 Investor Presentation
[3] AZEK Company Q4 2020 Earnings Call
[4] Diez, Roy. “New generation of composite decking: Trend to ‘capped’ products in tropical and exotic wood styles.” Home Channel News May 2014: 36. Business Insights: Global. Web. 17 Nov. 2020.
[5] AZEK Website azekco.com
[6] Kavanaugh, Catherine. “Azek Builds beyond the Deck with Versatex Acquisition.” Plastics News, 30 May 2018, www.plasticsnews.com/article/20180530/NEWS/180539988/azek-builds-beyond-the-deck-with-versatex-acquisition.
[7] Timbertech Website timbertech.com
[8] Madigan, John. “Deck & Patio Construction.” IBISWorld, July 2020, my-ibisworld-com.remote.baruch.cuny.edu/us/en/industry-specialized/od4717/products-and-markets.
[9] U.S. Census Bureau https://www.census.gov/housing/hvs/files/currenthvspress.pdf
[10] “U.S. Single-Family Homebuilding Accelerates in September.” CNBC, Reuters, 20 Oct. 2020, www.cnbc.com/2020/10/20/housing-starts-september-2020.html.
[11] “Modular Capacity Reduces Manufacturing Costs.” Newswise, Graduate School of Stanford Business, www.newswise.com/articles/modular-capacity-reduces-manufacturing-costs.
