Trex trades at $49.58 and has moved in lockstep with the market. Its shares have returned 17.1% over the last six months while the S&P 500 has gained 13.9%.
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Why Do We Think Trex Will Underperform?
We’re cautious about Trex. Here are three reasons we avoid TREX, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance is one signal of its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Regrettably, Trex’s sales grew at a sluggish 3.5% compounded annual growth rate over the last five years. This was below our standard for the industrials sector.
2. Free Cash Flow Margin Dropping
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Trex’s margin dropped by 7.3 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. If the longer-term trend returns, it could signal it is in the middle of an investment cycle. Trex’s free cash flow margin for the trailing 12 months was 17.2%.
3. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).
Over the last few years, Trex’s ROIC has unfortunately decreased significantly. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
We see the value of companies helping their customers, but in the case of Trex, we’re out. That said, the stock currently trades at 26.1× forward P/E (or $49.58 per share). At this valuation, there’s a lot of good news priced in - we think there are better stocks to buy right now. We’d suggest looking at the Amazon and PayPal of Latin America.
Stocks We Like More Than Trex
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