Welcome to real visions trade ideas today. We're sitting down with Brad saw flow of PA a research. It's great to have you here
Thank you for having me. I'm excited and this is your first time on real visions trade ideas
So could you give us a little bit of your background on what you do? Sure. So PA research is a
fundamental research firm that I founded about nine years ago now and it the idea I had previously worked at a hedge fund and before
that at
JPMorgan as an elite south side analysts. I wanted to bring an absolute return focused product
Which means I generate not only Long's but also short ideas
To the market that was backed by not only rigorous fundamental analysis, but a ton of primary research
So for your viewers, it's kind of a hedge fund quality research product with no agenda
No investment banking conflicts. Just get the idea. Right? Let's generate high returns our investment ideas, right? Okay
So with that in mind, what idea do you have today today? We're gonna focus on treks, which is a composite decking
manufacturer based in Virginia
The company's name is probably if you have a deck you've maybe have considered purchasing their products
They have gained a lot of share over the last several years
And due in large part to a number of factors
but there's been a movement towards replacing wood decking with composite decking and if you're not familiar composite decking is made of
recycled plastic bags bottles other things combined with wood products to create what people hope is a
Experience that resembles wood and that will last a longer period of time now, we have a bearish view on treks
which the stock itself has done well over the last several years but our
bearishness is based on the view that the company is now facing a huge increase in competition at a time when they're having
Significant manufacturing problems. So before we start on the on track
it's important understand who they're competing with and how that's actually changed in a meaningful way the last two three years, so
the industry
If you go back to the last cycle composite decking actually took about 24% of the linear feet installed in the United States of decking
So one of the things that I think investors trip up on as they say well today
It's 18 to 20 percent of the decking industry is composite decking
The deccan suggestion is lost share and the point of this is that it is very expensive, right?
so what's happened in the industry is that you have an
Influx of competitors and an influx of competitors who are now trying to bring lower price product to market
so in the case of tracks
Historically, they've had some competition there's dozens of players out there
But in the last few years you've seen a lot of acquisition active activity in this space. Where a
Company called fibrin was acquired by Fortune Brands
Universal Forest Products, which is a big wood distributor and across the country acquired their own platform
And then you've had a couple other acquisitions that were made in the space and now instead of treks really competing against
A few other players that were not as well capitalized they are competing against
increasingly a swath of companies that have
Distribution across the country. So you have fiber on you have a brand called decorator's which is owned by Universal Forest Products
You have timber tech which is all my ASAC and interesting enough at the start of this year timber deck launched its first ever
advertising campaign
national TV advertising campaign in our research suggestive gained a ton of consumer mind share and
Broader backing from distributors. So you look at tracks, which has had a nice growth for a long period of time
Now there's suddenly facing competition from large. Well capitalized companies and
Here's I think the most interesting part attracts is that if you look across the building product space most companies app
Operate with gross margins around 23 to 25 percent Trek's has a 43% gross margin
Now there are a number of factors that contribute that one is the pricing of the product
two is that they were running their manufacturing facilities at
max
Utilization and three is that they really have not faced a ton of competition. So now you have competition coming into the market
competition that's gaining distribution and
What's most interesting is that in the last three four quarters Trek suddenly has had major execution problems
So they've tried to roll out this new lower priced product that they hope will accelerate
adoption of composite decking
That will cannibalize their gross margins unequivocally. So there's that dynamic but separately the management team is had a hard time getting the action
right for these new products
So what happened? This spring is that they actually fail to deliver product to their dealers to their distributors?
So for the year, they've lost a ton of market share now
The decking orders come in at least the initial orders for spring/summer selling season come in, November and December
So if we look towards the fall
part of my thesis is that the company will lose share because
These competitors are now in the marketplace at the worst possible time for the company when they've actually failed to deliver
so the market when I say the market in the investment community views this stock this company is this
Massive secular grower the stock trades in nearly 30 times earnings. My view is that they're going to struggle
With gross margin compression and slower sales growth as a result of competition
So there's a lot of specifics with the treks itself, but I want to talk a little bit about the sector overall
We recently had Jay Van Sciver on he's the industrial sector head at hedge eye and he had this to say about the space
So you had a series of really unusual and exceptional events happen to the building products construction material space first
You had tax reform tax reform generally made your house and even the most optimistic view less
It attacked Shultz are a lot fewer people are taking advantage of the tax benefits afforded to residential housing
Second you had 125 years you've never had more rain than you had in the first half of 2019
I think is a stat that people haven't quite internalized
But it was the wettest year in the period that note was measured over the last 12 months, right?
they've been doing that for a long time since like
1895 and the third thing is we had a spike up in interest rates and you know the middle of
2018 and interest rates are now down and we tend to see on average
Construction spending respond to lower interest rates with about a seven-month lag
So we should as we enter 2020 least on a relative basis have a better environment for residential construction
Building product suppliers like mohawk. All right
so with mortgage rates declining and with the weather possibly improving do you think that could be something that could
Specifically buoy trucks sure so I know in the case of Jays
Arguments he was talking about mohawk, which is actually start stock. I personally own
and has been
as a firm I published my
portfolio holdings
every quarter so my subscribers can see that but
So much about Mohawk has to do with how they're dealing with LVT and some of the manufacturing issues. They've had
Certainly lower rates will help them lower rates will help anyone in the broader construction space so I don't disagree with that
the weather element which is interesting a lot of the building products companies have complained about them another company beacon roofing which is
Well the largest roofing distributors in the u.s
Missed badly this most recent quarter and they talked about the rain so that there's no debating that that better weather will help
And I would say that composite decking currently because of the credit conditions
The category is growing at a low double-digit rate
and my checks with dealers suggest that they you know through this spring and summer they were
Let's just say on average expecting mid-teens and then they do suspect some slowing in the back half
Certainly trikes will continue to benefit from that
yeah, my expectation is that
Relative to the share gains. They've had up until this point or really up until 2019
That they will start to show slower growth in the industry
and then again from an earnings perspective the margin dynamics for this company are about to change drastically and so you have a scenario where
you know, I think the company's earnings could ultimately be 25 to 40% below where the street is and
In that scenario, I expect a massive rewriting of the stock going from hey, we have this huge secular grower and have high margins
I mean a
scary high margins for a building products company and that you have some mean reversion in that margin profile and the growth rate and
that leads to
what I think is a stock that's trading in the low 80s now can trade as low as 35 40 now the stock over the
Course of the past year has seen some pretty choppy action
It recently released earnings and shot up out of that range that it was in it
Shut up about 20% Is that a concern here? And and were you short the stock before earnings releases?
Your second question first. Yes about the stock. We you know, we introduces a short idea in March of this year
My timing there wasn't wasn't exactly perfect
But you know, we take a long-term view. Most of the short said I'm looking at our kind of two three years in duration
as far as the action in the stock, the volatility is really surrounding the production issues that they've had at both their Winchester plan and
Nevada plants where again, there is a big question whether the company can consistently execute on
Producing both their high-end traditional product which is called treks transcend and this new lower priced product called trucks enhance
Getting those lines up and running is create a lot of production problems
They were also trying to do so many different things. They're launching new products. They're trying to increase capacity at their existing plans
And again now facing all sorts of different
Competitions so the volatility around the stock really has more to do with their execution issues
Not so much with the the broader industry trends. So even though we saw bullish earnings outlook yourself fairly booked bearish on the stock
Yeah, it should have spent a little more time talking about it would actually happen with earnings
So the company in the quarter of the second quarter, I actually missed their gross margins or what they had got it to
And they were all set. That was some other error
So I'd say the actual quality of their earnings beat was very low. The sales number was not great
The reason why the stock traded up so much is that their guidance for the third and fourth quarter?
They basically said we have all these catch-up sales to do
Because again, we weren't able to deliver a product in the channel inventories in the channel have been depleted to some level there
There's been a drawdown and so we need to restock
so
What's really happened in totality is that earnings? That should have been delivered in the second quarter been pushed to the third and fourth quarter?
Some kind of changing the seasonality the business at least for this year
Again, my view is what happens next year is gonna be a very different selling landscape for the company
Alright, so could you talk a little bit about your target price and also where you would stop out of this sure
So we expect the the company's earnings to disappoint
2020 2021 as this competition dynamic takes hold and I think the company will continue to struggle some of these execution issues. So
We think the stock in trade
236 is our official target, which is 15 times by 2020 earnings number as far as being stopped out
From a stock price perspective obviously everyone wants to manage risk, but I'm you know
Someone who's fundamentally focused and what's going on in the industry. It would have to be a change in the
competitive dynamics the company's ability to deliver incremental gross margin in excess of 45 percent some other factor that would cause me to read
Recalibrate how I was thinking about the name
Not necessarily an absolute price now in terms of that. What do you see as being the biggest potential risk to this Shores basis?
Yeah
I think you know you've touched and we've touched on this several times is that the category growth is very strong
And so, you know even a poorly run boat in a rising tide and will still motor along, right?
So that's what's happened for trucks this year and certainly for the stock
so that to me is the biggest risk is how long can
the overall demand and this shift from wood to
composite decking a lot of people view that as a secular trend and there are people in the industry trying to lower the price of
Composite decking to drive that trend, but that's that's going to be
The momentum for the business the only you know from a US about this earlier about from a credit perspective
I don't think people are cognizant of how much these businesses are really reliant on
all sorts of exotic forms of credit so
That is a really important dynamic and it doesn't get talked about enough around this company great
Thank you so much for joining us. Thank you for having me. So Brad is bearish on Trek's
Specifically, he likes shorting it at current levels and sees downside risk as low as 36 dollars over the next two years
Just remember this is a trade idea and not investment advice
Make sure to do your own research consider your risk tolerance and invested cording. Ly for real vision, I'm Justine Andre