Trex (TREX) Falls Sharply Despite Nice Q2 Upside; Inventory Drawdown To Impact 2H22 Pretty Severely
1:47 pm Tuesday, August 09th, 2022
Trex (TREX) is pulling back sharply today despite reporting strong upside results for Q2. This supplier of wood-alternative decking and railing has been benefitting from robust demand for repairs/remodels and the fact that outdoor living remains one of the fastest growing categories within the repair/remodel industry.
Unfortunately, the back half of the year looks less promising. Toward the end of June, Trex saw a sudden reduction in demand from its distribution partners, who are concerned about a potential easing in consumer demand due to rising interest rates, declining consumer sentiment, and expectations of a general slowing in the economy. As a result, these partners plan to work down the inventory they already have, rather than buy new product.
Trex believes the drawdown will likely impact the next two quarters and will be meaningful in nature. Management is forecasting 2H22 sales being in the $365-385 mln range, a big drop from $725 mln in 1H22. Since Q3 of last year, Trex believes the channel has added $200 mln in additional inventory from the low levels they carried in mid-2021. The current inventory drawdown should be substantially complete by year-end, when the channel will again be operating at very low inventory levels.
The timing of the inventory drawdown is unfortunate because Trex just launched a high end product in Q2, called Trex Transcend Lineage decking (refined aesthetics, trend-forward colors, heat mitigating technology). Also, Trex is in the process of building a third US-based Trex Residential manufacturing facility in Arkansas. Fortunately, it is not expected to begin generating product until 2024, so it should not create a glut of capacity in 2H22.
The irony here is that Trex believes consumer demand currently remains healthy. It sounds like the inventory drawdown is more of a cautionary, pre-emptive move by its pro customers. However, these distributors probably have a better handle on end consumer demand as they talk to them every day. Also, hurting Trex is that lumber prices have fallen due to a cooling housing market. That makes wood decking a cheaper option than it was last year.
Replacing a deck is an expensive undertaking and Trex is more expensive than wood. As such, many consumers need to take out a home equity line to finance the project. With rates rising, that becomes less feasible. With that said, there is the possibility that the lean inventories expected by year-end 2022 could act as a nice tailwind in 2023 for Trex, especially if the distributors outlook turns out to be more pessimistic than reality.
