by Debra Fiakas CFA
It appears to be the ‘summer of the small-cap’ as performance in the sector outpaces other sectors on the first day of summer 2016. In keeping with the adage “make hay while the sun shines”, we shifted into a higher gear to find promising small companies that might participate in the small-cap renaissance. Trex Company (TREX: Nasdaq) bubbled to the top of a couple different screens based on growth and return. There is much to like in a company delivering strong growth. A bargain price is just icing on the cake. With a ratio of 0.77 in price/earnings to growth, Trex is well frosted.
The company designs and manufactures outdoor decking, storage, fencing, stairs and railings, using wood waste and resin composites. Outdoor lighting is a recent addition to the product line. Its products are designed to be as aesthetically appealing and longer lasting than natural wood. The company delivered $54 million in net income or $1.73 per share from $451.7 million in total sales in the most recently reported twelve months. An impressive $59.2 million of sales were converted to operating cash flow.
The gaggle of analysts who follow Trex closely seem to think there is more of the same ahead. The consensus estimate for the full year 2016 is $2.16 in earnings per share on $471.8 million in total sales. Indeed, the group has been busy raising estimates in the last three months, with most of the incremental change weighted to the back end of the year. If achieve the 2016 hurdle represents 24% year-over-year growth in earnings. The 2017 consensus estimate of $2.46 in earnings per share suggests a slowing to about 13% annual growth. Yet in an economy struggling to eke out low single digit expansion a double digit growth rate stands out.
With all this good news it is surprising to find the stock trading at 24.5 times trailing earnings and 17.2 times the consensus estimate. Investors may be tempting their valuation of the stock because of the highly leveraged balance sheet. Trex is weighted down with $141.5 million in debt, representing a debt-to-equity ratio of 161.6%. The current ratio is 1.00, which may seem inadequate even if it has satisfied creditors.
It is also noteworthy that a long position in TREX presents some risk. The beta measure of 2.40 suggests a volatility that might worry conservative investors. There is no dividend that might otherwise provide a stipend during a period of price weakness. Despite the blemishes TREX is a ‘sweet peach’ for the summer of small-caps.
Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.