Trex: On Deck for a Comeback?

Shares of the building-products maker have rallied from recent lows as it tries to cut costs and boost efficiency

The U.S. economy may already be in a recession, and the outlook for the housing sector may still be grim, but investors may be betting that one building-materials supplier may be ready for a comeback after a long winter.

Trex Co. (TWP), the Winchester, Va., outfit that makes engineered decking, railing, and fencing, has recently a three-week rally in its shares, with the stock showing signs of life after hovering near 52-week lows for four months. The stock has advanced 23% since Mar 17.

With the price of crude oil surging above $100 a barrel, Trex, which mainly uses recycled plastics for its products, could be in a better position to survive the difficult market environment than some of its rivals that use virgin plastics.

"Virgin prices have been going up; however, Trex has been able to maintain pricing" for recycled plastic, said a Trex executive during the company's earnings call in February. "We are able to maintain and even essentially reduce our cost," he said.

According to Trex, some 70% of the 100 billion plastic bags handed out in grocery stores around the country every year end up in its factories, being repurposed into decks, rails, fences and other outdoor home improvement items. Every Trex deck contains approximately 140,000 recycled bags, said the company last month. The company also uses wood scrap and sawdust in its engineered products.

The company's stock has not proven as sturdy as its building products. Trex has suffered from poor capacity utilization at its factories and product quality problems, complicated by the weakening demand for homebuilding materials for the past year. The stock plummeted from $22 a share last May to only about $5 by the end of 2007. The stock has mostly traded in a range of $5 to $8 since then.

The company reported a loss per share of $2.75 in the 2007 fourth quarter, after massive charges related to obsolete inventory, fixed asset write-offs and other expenses. Still, some analysts saw some positives after a "kitchen-sink" quarter.

Trex has been through a management reshuffle, with a new CEO, Ron Kaplan, arriving just two months ago and a new CFO, and COO, landing in March. Recent efforts by the new management to reduce labor costs included staff reductions aimed at saving the company $3.5 million.

"Under new management, Trex is making a concerted effort to improve in every key facet of the business, but particularly in quality and production efficiency," wrote Stifel Nicolaus analyst John Baugh in a Mar 11 research note, after he met with the new management of Trex. Baugh has a hold rating on the company. (Stifel expects to receive or intends to seek compensation for investment banking services from Trex in the next three months.)

"Those internal efforts to improve operations and reduce costs are positive and I think they are moving in the right direction," says Keith Johnson, an analyst at Morgan, Keegan & Co.

"But it happened at a time when the home remodeling market environment is challenging, and it could be an especially difficult situation for discretionary home building products maker like Trex," he adds. Johnson maintains a market perform rating on Trex.

Another challenge for Trex: Its debt load. The company’s long-term debt to capital ratio swelled to 58% at the end of 2007 from 19% a year earlier, according to data from Capital IQ.

But it seems that some insiders are not discouraged from buying the company's stock. New CEO Kaplan bought 10,000 shares recently and last week (April 1) two company directors bought stock when the price was at 8.28 per share, according to SEC filings.

With its factories running not anywhere close to full capacity, Trex has relatively limited needs for capital expenditures for the near future, while maintaining substantial operating leverage, said Stifel's Baugh in his Mar. 11 note.

That's a positive aspect amid the depressing macro picture and the company's weak financial condition.

Other positives for Trex include a leading market share of roughly 30% to 35%, a robust brand, and industry-best distribution network in the high-growth wood-plastic composite (WPC) decking market, according to a Feb. 27 research note from Wachovia.

Investors may be nibbling at Trex’s beaten-down shares now, but if the economy should prove far weaker than expected – or the housing market continue to tumble -- their optimism will be tested in the months ahead.

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