Hourglass Journal - Building Moats, $TREX, & Insider Buying
Issue XX - Recapping a Week in the Markets: Dec. 04 - Dec. 08
Welcome to the 20th edition of the weekly Hourglass Journal! If you’ve been reading these for a while, you may notice that this Friday issue has got a little rebrand. Other than a wee name change, though, everything else is the same. You can still expect the normal watchlist stock, investor highlight, and investing tidbit, as well as an update on what’s been going on at Hourglass since last week. So let’s get right into it.
“All overnight success takes about 10 years.”
- Jeff Bezos
Weekly Watchlist Stock
Trex Company - TREX 0.00%↑
Who says you can’t make money investing in good companies? Trex Company is a leading manufacturer of decking boards that are made from 95% reclaimed & recycled materials, and is one of the largest recyclers of polyethylene in North America. While approximately 3/4 of decks and railing in the U.S. are made from timber products, Trex doesn’t screw around with any of that. Its decks are made entirely from composite materials, which are more expensive upfront, but hold several advantages over traditional wood products for customers:
Longevity - Composite decks last a long, long time. Even pressure treated lumber, on the other hand, requires full replacement at a minimum of every 30 years - even with diligent upkeep.
Low maintenance - Wood decks, even those made with treated lumber, are subject to insect infestations, warping, and weathering from the elements. They look fantastic when they’re first installed, but without yearly re-staining (which can get very expensive and time-consuming), they quickly start to look awful. Composite decks are immune to all of this; they keep that “freshly installed” look for years without any upkeep required.
Less expensive - Upfront costs for composite decking are greater; even the cheapest option from Trex costs double that of pressure-treated wood options. Over the long-haul, though, the lack of maintenance and longer lifespan makes composite decking a far less expensive option.
Environmental benefits - Consumers across a variety of categories are becoming more environmentally-conscious, and homeowners are no different. Not only can Trex customers feel good about not supporting the (often harmful) timber industry, they can also feel great about having their next deck built from recycled plastics.
Same great look - In the past, composite decking has looked absolutely terrible. Lifeless, fake, and lacking any personality, it did very little to inspire potential buyers that may have been interested in the benefits but were unwilling to have an ugly deck. That has changed. Composite decking now looks comparable, and often even better, than pressure treated lumber decks.
Given the advantages, it’s a miracle to me that not all decks are made with composite materials. That started to shift somewhat during the Covid pandemic, when Trex had a huge run-up alongside other home maintenance and repair companies. Growth has slowed since the pandemic highs, especially with tighter consumer budgets that have put home renovations on hold, but the underlying thesis on the business remains the same; composite decking makes up only 25% of the total decking and railing market in the U.S., and there is significant opportunity to spread the gospel on composite decking and penetrate this market further.
Trex, as a leader in this space, has the opportunity to take advantage of what is estimated to be an $13.7bn market in the U.S. alone, with tailwinds from environmental concerns and a housing shortage that encourages more homeowners to renovate rather than move. And Trex’s opportunity spells opportunity for investors to profit from the growth and tailwinds in the industry.
It’s not blistering growth, mind you - revenues have grown at a 10% CAGR over the last 5 years and earnings at 10.5%. But it’s solid and sustainable growth that isn’t set to slow meaningfully over the long-term, despite the temporary drop from tightened consumer spending. It’s also a very high-quality business to make up for that - capital efficiency metrics are elite, with a 25% ROIC, 31% ROE, and 24% return on total capital on a TTM basis. Margins are strong bordering on amazing for a manufacturer, debt is minimal, and the company has been repurchasing and retiring shares to drive earnings for shareholders.
There’s a lot of things to like, but there are a few concerns I have from a surface scratch:
The valuation is something to behold, just based on multiples - 7x sales for a company growing revenues by a 10% CAGR over the 3 years seems a little rich. 186x free cash flows seems more than a little rich, and a FCF yield of just 0.5% is enough to make a grown man cry. And that’s a perfect segue into the next concern.
Free cash flows on the business are pretty minimal, with just $79m in FCF on a trailing twelve month basis. This may not be a huge concern - with a current debt ratio of 1.5, cash flows are still adequate enough to handle the small amount of debt on the balance sheet. Trex also doesn’t grow by acquisition and seems to follow a pretty organic growth model, so it doesn’t necessarily need huge sums of cash. But it would still be great to see stronger cash flows for future share buybacks or pursuing growth adjacent to the ‘outdoor living’ market base that Trex serves.
Overall, this is a really strong business with interesting growth potential. The valuation is really my primary concern, but as I’ve just scratched the surface on Trex, I can’t do anything to dig beyond valuing it by multiples. I’m going to add it to the watchlist and dig some more into the valuation to see if I can make any sense of it beyond the (egregious) multiples.
Investment Talk & Ironside Research
This week’s investor feature is an article that& collaborated on that dives into moats - aspects that make a moat and how to analyze the moat potential of an investment.
Moats are a crucial part of finding good investments - they refer to the ability of a company to protect its market share, the competitive edge that allows it to operate in a favourable environment that competitors aren’t able to disrupt. The returns from companies with strong moats have outperformed the wider market by a significant margin - this article is a great overview not only on what moats are, but how to identify them.
It’s a well-written and quick read that gives investors some crucial questions to ask themselves as they try to find the next great investment opportunity. Give it a read below and follow the two authors for the rest of their content while you’re at it!
Insider Buying & Stock Performance
One of the key parts in my investment research process is checking in on insider transactions - a company management buying or selling shares of the company they manage. Without a doubt, no one is more capable than a company’s management team to tell if a significant downswing is coming or, conversely, an upside swing. Keeping an eye on the prices that insiders are paying if they’re buying shares help to give a rough idea of what management thinks is a fair value on the company.
In theory, monitoring when insiders sell could also help to see when management thinks shares are overvalued. However, it’s a little more difficult to nail down on the sell-side. In the wise words of Peter Lynch, there are any number of reasons that insiders sell, whereas there’s typically only one reason they’re going to buy - upside potential.
Longer-term sell trends can still be indicative, though - if multiple members of management are selling over an extended period of time with little to no buying to balance it out, it’s likely management sees something coming. A great example of this is XPEL. During my research on this company, I noticed that management was offloading stock like there was no tomorrow - these sells took place just before pretty significant competitive concerns came to light and shares in the company plummeted more than 35%.
It’s no surprise, therefore, that share performance is quite strongly correlated with insiders buying or selling shares, especially when transactions come in big bunches. This isn’t universal - some companies underperform when insiders buy, and vice versa on sells. But the research overwhelmingly supports the connection between losses after insider selling, and gains after insider purchases. It’s one of the things I always look at before making a final investment decision, and I believe insider activity is a great factor to work into research processes.
What’s New at Hourglass
The Trade Desk ($TTD) Part 1 - A New Age of Advertising
I decided to dream big for episode 20 of the Hourglass Investing Podcast - so big, in fact, I had to split the episode into two parts. The Trade Desk is creating a new model for advertising, one which I have high conviction as being the future of online advertising - programmatic advertising.
With tailwinds from the adoption of connected TV and increasingly digital modes of advertising, The Trade Desk has been one of the best performing stocks since its IPO in 2016, delivering a more than 50% CAGR to early shareholders. Now sitting at ~$35bn in market cap, the question is whether that growth will continue into the future.
Part 1 of the mini-series I’ll do on The Trade Desk dives into the business model and what The Trade Desk actually does, what programmatic advertising is, and CEO Jeff Green. Part 2 will be released next Tuesday and will dive more into the fine grain of the company - balance sheet, valuation, growth opportunities and moat against competitors. In the mean time, though, you can give Part 1 a listen below.
Topicus is a spin-off from a Canadian darling, Constellation Software. A blend of the masterful playbook from Constellation’s M&A process with an increased focus on organic growth and a fragmented European market, Topicus offers investors an opportunity to wind back the clock and get in on Constellation when it was only an $8bn company.
This article is fresh off the press, having just been released yesterday in the late afternoon, and is one of the more valuable deep dives I think I’ve done. Not only does the company offer very intriguing growth potential to investors, it’s also exceedingly hard to find information on. This is one of the deep dives I’ve had to put the most time into collecting information on, and you can find it all summed up here in a half-hour (ish) read.
I hope you enjoy, and if you get some value out of it, please share it out there into your investing circles!
That’s all for this week! I hope you all have a fantastic weekend, and happy investing when we get back to it on Monday.
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