WestRock: Expect Good Things As The Merger Synergies Start To Flow

| About: WestRock Company (WRK)


Improving industry and good execution suggest good times ahead for the equity shareholders.

Merger synergies are starting to flow through and the company seems to be getting more aggressive, with help from fast improving financial position.

Deleveraging the balance sheet is high on the priority list and cash flows are strong enough to allow the same.

Finally, WestRock (WRK) seems well positioned to deliver on the promise. Considering the industry is also turning the corner after years of consolidation and backed by a relatively stable macroeconomic environment, fundamentals have enough room to improve further and deliver. The business may have already benefited from the weak commodity prices, but gains from productivity and volumes improvement may drive the next leg of growth. Last quarter, strong free cash flow, which came out ahead of the previous expectations, removed any liquidity related doubts and deleveraging might drive the next leg of value for the shareholders, given the debt of close to $5.9 billion.

Improving industry

As covered in my recent notes on KapStone Paper & Packaging (NYSE:KS) and Xerium Technologies (NYSE:XRM), the health of the industry is improving, whether one looks at the capacity, inventory or the pricing discipline followed by most players. Most factors, including consolidation, driving the improvement visible in the industry seem to be more permanent in nature than seen in the past.

Even though the strength of fiber and labor costs has been unfavorable for the company, WestRock has benefited from commodity deflation, weak material costs and soft energy prices, things that continue to provide a nice tailwind to the business.

Consistently, one step at a time

Operational improvement, M&A and geographical realignment are some of the levers that are slowly positioning the business for better topline growth and profitability going forward.

The company has talked about delivering close to $1 billion worth of productivity improvements by fiscal 2018 and looking at the $350 million of productivity improvement until the end of last quarter and $425 million of annualized run-rate of synergies during the previous quarter, the number looks easily achievable, if not conservative. Better sourcing benefits from internalization initiatives; improved inventory and better logistics management may continue to deliver improvements.

Besides the spinoff of Ingevity Corp. (NYSE:NGVT), a specialty chemicals business that is performing well after the separation, the company has acquired businesses like SP Fiber and Cenveo and formed JV with Grupo Gondi. Most of these deals should start delivering over the coming quarters. SP Fiber deal, which includes two mills and a 48% stake in renewable energy JV with Georgia Power, will allow the company to take control of one of the largest sources of recycled paper. Grupo Gondi, company's JV in Mexico, has the ability to increase its position in a faster-growing geography and partner with a high-quality aggressive team, as evident from the acquisition as well as an order of 11 new production lines by the Grupo Gondi's management after the availability of new capital. Given the improving cash flows, the company might get active in acquiring small players in U.S. or expand its presence in Brazil, a market for close to 60% of the company's containerboard export to Latin America.

More value creation for the shareholders in sight

Hardly any investor will complain about the capital allocation so far. The company has spent close to $850 million on capital expenditure; dividend yield of more than 3% is more than 50% higher than the average S&P stock and the management has repurchased more than 12 million shares since the merger. Going forward, things may get even more exciting for the equity shareholders, given the improvement in margins visible, free cash flow that is expected to reach $1 billion and debt repayment high on the priority list.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.