WestRock Company (NYSE:WRK) Q4 2018 Earnings Conference Call November 5, 2018 8:30 AM ET
James Armstrong - Vice President, Investor Relations
Steven Voorhees - Chief Executive Officer
Ward Dickson - Chief Financial Officer
Jeffrey Chalovich - President, Corrugated Packaging
Robert Feeser - President, Consumer Packaging
Chip Dillon - Vertical Research Partners
Brian Maguire - Goldman Sachs Group Inc.
John Babcock - Bank of America Merrill Lynch
Steve Chercover - D. A. Davidson & Co., Inc.
Debbie Jones - Deutsche Bank
Mark Wilde - Bank of Montreal
Gabe Hajde - Wells Fargo Securities LLC
Mark Weintraub - Seaport Global Securities LLC
Paul Quinn - RBC Capital Markets
Mark Connelly - Stephens, Inc.
Adam Josephson - KeyBanc Capital Markets
Good morning. My name is Marcella, and I will be your conference operator today. At this time, I'd like to welcome everyone to the WestRock Company Fourth Quarter and Full-Year Fiscal 2018 Results Call.
At this time, I'd like to turn the call over to Mr. James Armstrong, Vice President and Investor Relations.
Thank you, Marcella. Good morning, everyone, and thank you for joining us today. We issued our press release this morning and posted the accompanying slide presentation to the Investor Relations section of our website. They can be accessed at ir.westrock.com or via a link on the right side of the application you're using to view this webcast.
With me on today's call are WestRock's Chief Executive Officer, Steve Voorhees; Ward Dickson, our Chief Financial Officer; Jeff Chalovich, President of Corrugated Packaging; and Bob Feeser, President of Consumer Packaging. Following our prepared comments, we'll open the call up for a question-and-answer period.
I'd like to point out that during the course of today's call, we will be making forward-looking statements involving our plans, expectations, estimates, and beliefs related to future events. These statements may involve a number of risks and uncertainties that could cause actual results to differ materially from those we discuss during the call. We describe these risks and uncertainties in our filings with the SEC, including our 10-K for the fiscal year ended September 30, 2017 and our 10-Q for the quarter ended June 30, 2018.
Additionally, we will be referencing non-GAAP financial measures during the call. We provide reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the appendix of the slide presentation. The slide presentation is available on our website.
So with that said, I'll turn it over to you, Steve.
Thanks, James. Good morning. Thanks for joining our call today. It's an exciting time to be at WestRock. We have a lot of good things going on. On Friday, after a long wait to receive regulatory approval, we completed the KapStone acquisition. I'm enthused about the positive impact that KapStone will have on WestRock and I welcome our new team mates from KapStone and look forward to building our future together. The wait was worth it.
This morning, we reported strong fiscal fourth quarter and full-year fiscal 2018 results. We met the key financial goals for the fiscal year that we set out at the beginning of the year. Sales increased 10% and adjusted segment EBITDA rose 26% year-over-year with adjusted segment EBITDA margins of 17.8% in fiscal 2018. Adjusted EPS rose by 56% and our adjusted operating cash flow increased 23%.
During the year, we significantly improved our Corrugated Packaging margins, generated strong cash flow, and improved our business with both capital investments in the Plymouth Packaging and Schluter acquisitions.
Moreover, during the year, we made significant strides in providing differentiated and sustainable paper and packaging solutions that help our customers win in the marketplace. We're helping our customers win in eCommerce markets with shelf-ready packaging, with brand activation, with plastics replacement, and with supply chain optimization that includes in many cases installing our proprietary machinery at our customers' locations. Over one-third of our sales are to customers that buy both corrugated and consumer packaging from WestRock.
In fiscal year 2019, we'll continue to implement our differentiated strategy and add to our capabilities through several strategic capital investment projects at Florence, Porto Feliz, Covington, and Mahrt and of course through the many opportunities that KapStone provides. WestRock's well-positioned to provide attractive opportunities for our team to deliver outstanding value to our customers and our stockholders.
Let's turn to the quarter. Sales increased $176 million year-over-year, adjusted segment EBITDA increased by $153 million or 23%, and adjusted EPS increased by $0.42 to $1.29 per share. Adjusted operating cash flow increased 81% from last year. KapStone performed well in the September quarter reporting a trailing 12-month adjusted EBITDA of $551 million and quarterly adjusted EBITDA of $163 million. This is well above KapStone's run rate of $500 million at the time we announced the acquisition. It's a very positive reflection on the KapStone team.
KapStone team delivered outstanding results during the uncertain period of time while we were waiting for regulatory approval. Underlying supply and demand fundamentals continue to be very favorable. Operating rates remain high across our business and backlogs remain solid.
Our total North American containerboard and Corrugated Packaging shipments grew by 4%, Mahrt shipments increased 1.7% year-over-year on a per day basis, and our Consumer Packaging business saw paperboard and converted products volumes rise by 1.7% year-over-year.
Our balance sheet is in good shape. We ended the quarter with a leverage ratio of 2.07x. With KapStone on a pro forma basis, our leverage will be about 3x excluding the impact of the $200 million of the full run rate of synergies and performance improvements that we expect from the KapStone acquisition.
Our qualified pension plans are over-funded by $300 million. Our pension investments are primarily in low-risk assets, which is an excellent place to be during this period of volatility in the financial markets. Our confidence in our long-term cash flows was demonstrated two weeks ago when the WestRock Board of Directors approved a 5.8% or $0.10 per share increase to the dividend.
We've increased the dividend by 21% since the formation of WestRock. At $1.82 a share annually, our pro forma dividend yield is more than 4%. The return of capital to stockholders is an important part of our capital allocation strategy. We've returned $2.3 billion to stockholders since WestRock was formed in the summer of 2015.
Let's turn to the Corrugated Packaging business. Corrugated Packaging industry remains attractive and growing and we've outgrown the market for the last 18 months. As I referenced earlier, WestRock's North American box shipments increased 1.7% on a per day basis and 3.3% on an absolute basis as compared to last year. This volume increase was driven by rising demand across most of our end-market segments, especially the eCommerce, food service, and retail markets.
Our integration level for the quarter was 73% and our integration level was 75% for the year. We ran very well and we're able to build our containerboard inventories back to where we'd like them to be. We're experiencing increasing demand as we enter the holiday season.
In October, our North American box shipments increased by 6.6% on an absolute basis and 2% on a per day basis with one extra shipping day in October as compared to last year. Our North American Corrugated Packaging business has made outstanding progress over the past six years. We've doubled North American EBITDA margins since 2012, which was the first full-year following the Smurfit-Stone acquisition.
During this quarter, North American corrugated adjusted EBITDA margin was 25.4%, 620 basis points higher than the prior year quarter. We have the people, the projects, and the programs in place to maintain the momentum we have to improve our performance across our system. We plan to do just that.
With the addition of KapStone, we have many opportunities to drive efficiencies across our expanded system. We expect to realize the $200 million in synergies and performance improvements by the end of fiscal 2021. Our Brazil team delivered exceptional results during the quarter with adjusted segment EBITDA margins of 27.1%. Construction at our new Porto Feliz box plant is on schedule and we expect to start producing sheets this quarter.
I'd like to take a moment and talk about the impact Hurricane Michael has had on our operations. As we previously reported, our Panama City mill sustained extensive damage and I'm extremely grateful that none of our teammates or any of their family members were injured in the storm.
Many of our teammates lost everything in the storm. We're helping them and others impacted with food, water, temporary housing, and supplies during this recovery period while providing financial assistance through the WestRock Employee Relief Fund. We remain committed to returning the Panama City to full operations and supporting the community for years to come. I visited the mill two weeks ago. I have to say I'm extremely proud of the way our Panama City team has risen to the occasion to take care of each other and also how they've worked hard to get the mill back up and running.
With the assistance of our WestRock team members across the company along with contractors and vendors, repairs are well under way. And on Saturday, we started running linerboard and expect to ramp up to a full production rate during the month of November. Our market pulp production line is expected to be operating at 50% of capacity in early December. We should be back to full operation in approximately six months.
The initial estimate of the property damage and business interruption insurance claim is $100 million. We have excellent property damage and business interruption insurance that will cover most of the cost of bringing the mill back to full operation. Except for a $15 million deductible, we expect the vast majority of the cost will be covered, but with some timing differences until insurance proceeds are received. As we recover, we've been adjusting the operation of our system to make sure that our customers are properly supplied.
We're investing in our business in Brazil to enable the Tres Barras mill to achieve its full potential. The upgrade includes the addition of Virgin pulping capacity, a new biomass boiler, a turbine generator, and debottlenecking of the two paper machines. The addition of the Virgin pulping capacity will provide more of low-cost eucalyptus pulp and allow us to eliminate our use of higher cost OCC.
The new biomass boiler and the new turbine generator will increase our electricity self-sufficiency to 85%. By debottlenecking the paper machines, we'll be able to produce total of 750,000 tonnes of containerboard per year that will support the growth at our Porto Feliz box plant while sustaining our supply to third-parties in the region.
Importantly, these investments will reduce the cost of all the tonnes we produce at the mill and will solidify our standing as owning one of the lowest cost mills in the world. When combined with our current box plant project Porto Feliz, the mill upgrade will increase Brazil's adjusted segment EBITDA by more than 125% and will improve our EBITDA margins to more than 30%.
In our Consumer Packaging side, shipments of paperboard and converted products increased approximately 1.7% year-over-year. We see rising demand in many of the consumer end markets, including healthcare, retail food, food service, liquid packaging, and beverage.
This was the fourth consecutive quarter of volume growth in our retail food business. Our customers are interested in our solutions that help them convert their plastics packaging to more sustainable paper-based alternatives. Our paperboard backlogs remained strong in the quarter and are currently between five and six weeks for all major grades.
Pulp & Paper Week published several price increases beginning in March across each of our consumer paper grades and we're implementing these increases in accordance with our contract terms. The Pulp & Paper Week published price increases affect approximately 50% of our business with the remaining business either being export business or based on mechanisms not directly related to the Pulp & Paper Week indices.
Adjusted segment EBITDA in the quarter was $275 million. The segment delivered productivity of $43 million, which was an important contributor to our results in the quarter fully offsetting increases in inflation of materials, energy and freight, and a significant part of wage inflation. We're investing in our Mahrt and Covington mills to reduce cost and increase our ability to meet the changing needs of our customers.
At our Mahrt, Alabama mill, we're replacing the existing 45-year-old coater with a new curtain coater that will improve machine reliability and reduce coating chemical usage and maintenance cost. This will improve printability, provide the flexibility for us to meet customer needs by shifting production between the two paper machines at the Mahrt mill. We executed a similar project at Mahrt in 2014.
At Covington, we're replacing the head box and upgrading other areas of our Number One paper machine to further improve our SPS products by lowering density and in the process, lower our operating cost. We expect the Mahrt and Covington projects to generate unlevered after-tax returns of at least 20%. The implementation of these projects will require an additional 72,000 tonnes of downtime during fiscal 2019 as compared to fiscal 2018.
The addition of KapStone to WestRock makes us a better company and brings us to a combined total nearly $20 billion in annual sales. Our broad portfolio of differentiated solutions has been enhanced overnight by the addition of a well situated mill and box plant system that fills in the North American footprint of our Corrugated Packaging business.
The acquisition also makes us the leading producer of kraft paper in North America and adds a new channel distribution to our portfolio. While the approval of the acquisition took us much longer than expected, the benefit is that KapStone delivered outstanding results that improved their adjusted EBITDA to $551 million. This reduced the purchase price multiple to 6.4x after synergies.
Our pro forma leverage after completion of the transaction will be about 3x, which sets us up well to return our leverage to our target of 2.25x to 2.5x. The complementary nature of our systems creates the opportunities to achieve the $200 million in synergies and performance improvements. We have a lot of pent-up energy to make these synergies happen. I've been very pleased with the response of our entire organization over the past week.
This weekend we began to ship additional WestRock boxes to several Victory locations so we're getting after it right away. I like the addition of KapStone's kraft paper products to our portfolio. This product line brings a whole new set of current and potential customers to WestRock. In fact kraft is an attractive substitute for plastic sacks, provides us with yet another alternative for us to replace plastics with sustainable paper products.
Importantly, kraft paper is an attractive grade for several of our mills that have the ability to swing production from containerboard to kraft paper and back again. KapStone's containerboard mills and box plants will be integrated into WestRock's Corrugated Packaging business led by Jeff Chalovich.
The KapStone system is just the right size for us. It's big enough to make a difference and small enough to easily fit into the existing regional structure of our North American Corrugated Packaging business. We'll operate the distribution business under the Victory name. Majority of their sales are corrugated boxes and related supplies. The business will be led by Bob Egan, who continues as President of Victory.
That concludes my comments and I will turn it over to Ward. Ward?
Thanks, Steve. Turning to Slide 12, we detail the key assumptions included in our fiscal first quarter 2019 financial guidance. We expect adjusted segment EBITDA in the first quarter to be between $737 million and $767 million as compared to $802 million in our fiscal fourth quarter.
Walking through the sequential bridge, we expect the acquisition to contribute approximately $90 million in adjusted segment EBITDA for the two months during the quarter. The next set of items that impact our adjusted segment EBITDA are based on the WestRock business excluding KapStone.
Pricing will be higher in both segments as a result of the flow through of previously published price increases. Volumes are expected to decline as a result of seasonality in our consumer business. We will take 60,000 tonnes of additional scheduled maintenance downtime across our corrugated and consumer mills and we have two fewer shipping days in the box business.
Input costs should be stable sequentially. Higher group insurance cost and a decline in non-cash pension income should reduce sequential EBITDA by $20 million. Typically, group insurance costs increase in the fourth calendar quarter as employees reach their deductibles. The recovery at the Panama City mill is a complex situation.
To clarify our earnings guidance for both the quarter and the year, adjusted EPS will exclude both Hurricane related damages and increased operating costs as well as associated insurance claim proceeds. Adjusted EPS will include the negative financial impact from lost production.
For the first fiscal quarter, we estimate $45 million negative impact from lost production. We expect increased D&A of $0.15 per share, higher interest expense of $0.09 per share, and an adjusted tax rate of 24.5%, and a slightly higher share count due to the election by certain KapStone shareholders to take WestRock stock for the purchase price. These items aggregate to $0.29.
Moving to Slide 13. We expect to invest approximately $1.5 billion of capital in our business in FY 2019. Our base capital, including KapStone, should be about $950 million to $1 billion with roughly half going to maintenance and half invested in high return generating projects. In FY 2019, we will also invest approximately $500 million in our strategic projects including Florence, Mahrt, Covington, and our two projects in Brazil.
Once in service, these investments should generate more than $240 million in EBITDA for our business. As Steve mentioned earlier, we also increased our dividend to an annual rate of $1.82 per share. Initially we have funded the KapStone acquisition with approximately $4.4 billion drawn under our bank term loan facility and other committed lines and cash on hand.
Post KapStone, we will look to potentially refinance some of the term loan with other debt capital. We have provided our estimated FY 2019 interest expense and interest income assumptions in the appendix. We expect to get back to our target leverage ratio of 2.25x to 2.5x during fiscal 2020.
On Slide 14, we outline our full-year guidance. We remain confident in our business, overall industry conditions, and our expected outlook in fiscal 2019. Our guidance includes 11 months of KapStone's results. We expect net sales to exceed $19 billion. Key growth drivers include the KapStone revenue, the full-year impact of previously published price increases in both segments, growth in corrugated box volumes, and stable volumes in consumer.
These increases are partially offset by the change in reporting of our recycling business to record external sales as a reduction of cost of goods sold. The recycling business is now accounted for as a procurement function. We also will have lower land and development sales as we complete the monetization program. We expect adjusted EBITDA to increase to approximately $3.6 billion. We've highlighted the KapStone contribution to our fiscal 2019 guidance.
In addition, you see the key assumptions across the rest of our business, including the flow through of the previously published price increases in both segments. These gains are partially offset by inflation, the impact of increased annual outages, and the implementation of our strategic capital projects.
In addition, the impact from Hurricane Michael, lower pension income, FX, and other items will have a negative impact of $100 million. We expect adjusted EPS to be approximately $4.60 per share driven by higher adjusted EBITDA partially offset by higher D&A and interest expense. In addition, we expect an adjusted book tax rate of 24% to 25% and 265 million shares outstanding.
Adjusted operating cash flow will grow to approximately $2.55 billion. Higher earnings will be partially offset by higher cash tax rate, acquisition related interest, and reduced cash flow from the wrap-up of our land and development business. This higher cash tax rate is due to the utilization of most available credits in FY 2018 and the positive benefit in FY 2018 of various tax planning efforts that we executed. To help you in your modeling, other assumptions for the full-year are included in the appendix on Slide 19.
I'll now turn it back over to Steve for closing comments. Steve?
Thanks, Ward. We've just completed a very good year, strong execution and strong results. Market conditions remain favorable. We're experiencing continued solid demand across the large majority of our markets. We're experiencing high operating rates and strong backlogs.
The addition of KapStone greatly enhances WestRock's geographic presence, ability to serve our customers, provides us significant opportunity for synergies and value creation. We're entering fiscal 2019 with sustained momentum and even stronger platform. We expect to productively deploy our capital and deliver growth in sales, earnings, and cash flows for the benefit of stockholders.
In closing, global demand for containerboard continues to rise roughly in line with global GDP and the world realizes that North America is attractively positioned with supplies of Virgin fiber, recycled fiber, and energy. A number of competitors have announced containerboard capacity additions in response to this increase in global demand. We are well-positioned in this competitive market to provide unique value to our customers through our broad portfolio of differentiated sustainable paper and packaging solutions.
For our strong execution and capital allocation, we'll improve our margins and grow our cash flow and use the strong cash flow to reinvest in our business and make acquisitions that support our strategy. We will return capital to stockholders by increasing our dividend over time and through share repurchases. This is a formula that provides significant opportunities for our team, our customers, and investors over the short and long term.
Now that concludes my prepared remarks. James, we're ready for Q&A.
Thank you, Steve. As a reminder to our audience to give everybody a chance to ask a question, please limit your question to one with a follow-up as needed. We'll get to as many as time allows. Marcella, can we please take our first question?
[Operator Instructions] Your first question comes from the line of Chip Dillon from Vertical Research. Your line is open.
Yes, and good morning. Thank you for all the details. My question mainly has to do with what we saw in the last several months and thanks for the October data. But in particular we saw a real big surge across the industry in export volume and I didn't know what was the genesis of that? Was there – I noticed that some of the published prices had really jumped farther than what we have seen domestically say since 2016, but I didn't know if it was just because of the attractiveness of those markets or if there was something else going on there and should we see these export trends continue?
Hey, Chip. Good morning. It's Jeff. So, I can speak for WestRock. As you recall, our ability this year to make our shipment since we've been running on basically full the entire year. This is the first quarter we didn't have any maintenance downtime so we were actually able to do catch-up on orders we've been pushing out all year.
So the last quarter, our shipments went up into export although for the year we're down over 100,000 tonnes in the export market, but we use this opportunity to catch-up in markets that we hadn't been participating where we had had customers and continue to push out. As you noted, our pricing has been stable in those markets and we took the opportunity to catch-up for our customers that we had been pushing out for most of this year.
That's helpful. And then just a quick follow-up. You mentioned in the guidance, Ward, the $100 million of additional expense and I assume that includes the portion of Michael that is tied to production not to the other aspects you mentioned. But could you give us a rough breakdown on how much is that impact versus the lower pension and the FX?
Sure. So the lower pension is approximately a third of the $100 million, the lower FX is another third, and then the residual – the timing of the recovery of the claims from our insurance carrier on the lost production is a portion of the remaining one-third of that $100 million.
Okay. Thank you.
Your next question comes from the line of Brian Maguire from Goldman Sachs. Your line is open.
Hi. Good morning, guys and congrats on closing on KapStone.
Ward, a question on the guidance as well. I just wondered what sort of commodity cost inflation you're expecting in 2019 and maybe you can just provide kind of a rough ballpark of where we were in 2018 for context there, and I think some companies are calling for an acceleration maybe in the 4% range or 5% range, but we're also seeing a little bit of flattening out in some key costs like freight. So I was wondering if you could also just kind of comment on what kind of trends you're seeing as we start the fiscal year off here.
Sure, so we're assuming between $280 million and $300 million of inflation for the full-year next year embedded in that assumption, because of the decline in OCC in the first half of fiscal 2018, we actually have a year-over-year decline of OCC of about $25 million.
So our average for the full-year of FY 2019 versus FY 2018 for OCC is down about $5 per ton. It's fairly stable in the first half of the year with current levels and then we have a small increase projected in the second half. We do have freight cost. Freight cost's up 5% on a year-over-year basis this year. It was closer to 10% and then embedded in that overall $280 million to $300 million obviously includes wage, benefit, and other cost inflation.
All right, great, that's helpful. And then just one maybe for Steve or Jeff, just on the decision and the timing to do the Brazil mill project now? You obviously have a lot going on in the Company with the KapStone integration, the project in Florence, the box plant in Brazil. Just wondered if – how you think about the execution risk on that and the complexity of all the different projects you've got going on right now?
I feel very good about our ability to execute the Brazil project. We actually pushed it out a little bit because of the box plant and so they've been well prepared for a number of months to go through and execute it. So they really could not be better prepared. Jim Porter, who many of you know has been spending a lot of time in Brazil and he's been there for a long time. But I know he was here last week, he's going to be there again this week. But I feel very comfortable with our ability to execute that project.
Okay. Thanks very much.
Your next question comes from the line of George Staphos from Bank of America. Your line is open.
Good morning. This is actually John Babcock on the line for George. Just want to quickly follow-up and it maybe a little bit early even to comment on this. But what sort of opportunities do you see to invest CapEx in the KapStone business? And then on that point, can you also talk about how KapStone might change the overall logistics across the WestRock platform?
Hi, good morning. So we've budgeted about $150 million in the incremental for the KapStone system and we believe that's sufficient based on what we know of the system to invest. We think we can do the same types of things we've done in our system, in the mills in the box plants. Their system gives us an opportunity to optimize our strategic sourcing model.
So there's lots of opportunities for areas where we commonly overlap in domestic, our trades, and our exports to really optimize for freight, for trend, for grades, and that's the work that starts literally today going forward. But that's a large part of the synergies of the $200 million, a large part of that is really in the productivity gains, the supply chain optimization, optimizing plant and customer pairing. So there's a lot of opportunity in the acquisition.
And just the capital at the run rate we anticipate.
And then just one quick follow-on here, just it appears you're expecting greater than $550 million in EBITDA, which seems to apply around kind of $600 million in full-year EBITDA for the business or maybe a bit more than that. Can you talk about some of the assumptions that gets you there and then also how you're thinking about the trajectory of the synergy capture?
So your assumptions are correct. I mean where they've got the – embedded in the KapStone business is you also have the flow through of the previously published price increases for the full-year on a year-over-year basis, similar inflation assumptions and volume assumptions that we have across our base box and containerboard business.
In addition, we are projecting that we're going to get to a run rate of synergies by the end of the first year of approximately $65 million to $70 million. So we'll get to achieve a portion of that across our productivity initiatives during the fiscal year.
Your next question comes from the line of Steve Chercover from Davidson. Your line is open.
Thank you. I had a question about the basis of the KapStone assets. So if my math is reasonable, depreciation is up about $100 million more than the KapStone's previous run rate and that kind of surprises me since we know the assets weren't brand new. So I'm just wondering do you have a lot of latitude in terms of how you write-up assets in an acquisition?
Well, so we are just now going through the valuation process of and the purchase price allocation. So our original estimate was the combined D&A would be between – it's going to be between $305 million and $310 million, which includes their base run rate plus the write-up and the purchase price allocation between the assets, goodwill, and the intangibles. So we are just starting to do that work now and we'll update you as we complete it.
Okay. Well, congratulations on getting that done and it's nice that it was operating so well. One other quick question about capital allocation and specifically as it pertains to returning it to shareholders. If the dividend's north of 4%, would that be an indication that the stock is too low and therefore buying back stock becomes more compelling than boosting the dividends in the future?
I think it's hard to make a judgment between those two things. I think if you look at our overall capital allocation, our leverage ratio at 3x. We're going to have an increased focus on reducing that. Beyond that, we'll go through – I'd say our consistent process of allocating capital across our business.
Think you will see and as demonstrated by our capital expenditures for this year, we think we've got terrific opportunities to invest back into our business. The weight of those projects is on generating returns by reducing cost so by generating very high returns on these projects, we think that's a very good use of capital. And as I said, we'll look at beyond that first on reducing debt and then as we have the dividend and we'll continue to look at share repurchases.
Your next question comes from the line of Debbie Jones from Deutsche Bank. Your line is open.
Hi, good morning.
Good morning, Debbie.
Thanks, my first question on KapStone. I just wanted to see if I could flush out some of the synergies that you're calling out a little bit more. How much of that is related to mill improvement versus improvement at the plant level and specifically if there is anything to note around investment at Charleston? And then on the box plant side, how long does it really take to implement the strategies that you have in your legacy business into the system at KapStone?
Sure. So Debbie, there's about 75% of the overall synergies lie in fiber energy mill performance improvements, the mill network optimization, and then supply chain optimization. So that's a large preponderance of that – the synergies.
You have the converting footprint optimization, plant and customer pairings are the other part of that 75% and then you get administrative efficiencies, procurement, and the Victory integration is the other 25% of those efficiencies.
Again in our run rate of $150 million in capital that we've targeted for the KapStone assets, we believe there's – that's well funded for all of the projects we'll need to do in any of the mills and the box plants moving forward.
Okay. And then second question on your segment performance. I actually got Corrugated, which is quite strong and Consumer generally in line except for the volume mix side of things at least versus my expectation. And I was wondering if you could break out on the volume price mix side where there may have been some surprises or not. And then in your implied guidance for 2019, is volume growth a driver of improvement year-over-year?
Hi, Debbie. This is Bob. Just on the volume mix side so as we announced that our overall volumes were up about 1.7% and that's paperboard and converted products, we did see lower display sales as well as lower pulp sales, which would have impacted that volume mix bar that you're referencing.
Yes. And so is it – should we expect that to continue to be a negative in 2019 or is there just something seasonal that because obviously you're converting product shipments are doing quite nicely?
Yes. We said the contribution of volumes across our Consumer business were going to be stable in the assumption on a year-over-year basis for FY 2019 versus 2018.
Okay, great. Thank you.
Your next question comes from the line of Mark Wilde from Bank of Montreal. Your line is open.
Good morning, Mark.
Jeff or Ward, I wanted to just come back to kind of KapStone CapEx looking a bit further out. There have been a couple of issues that have been discussed around the KapStone assets, the recovery boilers at Charleston and then the potential debottlenecking out at Longview, and I wondered if you could just sort of address both of those issues?
So they had a very successful recovery boiler install, I think this last year that was reported I think a quarter or so ago. So we haven't seen anything there that we're concerned about. And then as a matter of course when we look at assets, we're always looking to elevate the constraint in the system whether that's on the paper machines or through the box plant.
So we'll continue to look at process, at capital investments, opportunities with Lean Six Sigma, what we do on our system today. And as we get more embedded into the operations, we'll have a clearer view and we expect to do that starting this morning. We have people at all the mills, box plants, and corporate headquarters. So we are in the facilities as of this morning first thing and we'll be there for all the shifts and our work's beginning.
Okay and Jeff just to come back to that Charleston issue. So I thought there were a couple of recovery boilers down there that might need work, can you just clarify that?
So there's nothing again that I've seen that is going to put us outside of what we project in our more $150 million, Mark. So as we get further into the assets and understand what the capital plans were, I'll be better able to comment on that moving forward.
Right and then just a follow-on. Bob Feeser, I wondered if you could put a little more color around the softness in pulp and displays in Consumer Packaging. It would seem like this last quarter should have been a good seasonal quarter for displays. And I also wondered if you can just talk about any potential to move these boxboard hikes through more quickly. I mean it is pretty striking when you look at this quarter's numbers that even with the market so tight, cost was – didn't offset pricing in the quarter?
So maybe I'll take the pulp and we'll talk about displays in just a minute. The pulp decrease was really relatively small in our overall system and within our mix. There will be changes like that from quarter-to-quarter.
Just a quick comment on the pricing, Mark, so as you know, there have been six published increases in 2018 and we've had two of those across our – each of the major grades with a $35 published decrease that flowed through our first half of fiscal 2018.
You can see from the consumer bridge that we captured about $18 million of that in the fourth quarter from the increases that were published in March given our roughly three quarter lag to capture.
And just as a reminder, the pulp and paper price changes apply to about 50% of our business. The remainder of it is negotiated contracts, some that includes cost models and inflation industries, and we're always negotiating with our customers around commercial terms. And the bottom line, the market continues to be very competitive and we're succeeding by really creating value for our customers around our differentiated solutions.
Mark, on display, you said it was a seasonally strong quarter and that's true and it was even stronger last year than it was this year. So that's why you have sequential – you have a year-over-year sales decline in display.
Okay. Fair enough. Steve. I did want to just also kind of compliment you on these containerboard margins. It's pretty impressive what's happened over the last four or five years just you relative to the competitors?
Thank you for noticing. It's much appreciated. A lot of work has been done by the team to do that.
Your next question comes from the line of Gabe Hajde from Wells Fargo Security. Your line is open.
Good morning. Thank you for taking the question and congratulations on the KapStone deal. First one, kind of centers around global flows for OCC, one of the things that I found peculiar was that export tonnage is actually up, but yet prices are down. So I was just curious if you could comment at all on what you're seeing with I guess export demand versus local demand here?
Sure, this is Jeff. So from our exports, what we're seeing is really only the high class fiber so Number 12, which is a cleaner fiber. That remains I'd say stable to strong. And then the rest that's been more mixed office waste or lower class OCC has not. So there had been a bunch of licenses issued, but probably only 50% of this is to China specific going into the country.
There are some other Asian countries taking more in cleaning so they're cleaning it and then shipping it, but we see that falling off also as these other countries are going to do the same thing we believe from what we've been told on their waste in fiber. But from our system, the exports are not up, they're down and the only thing we're seeing that's maintained is really the Number 12 OCC in our world.
Okay. Thank you. And then I guess a question on the integration rate, you guys at around 75% in the full-year and I think KapStone was something around 70%. I guess the risks or the opportunities around that in terms of increasing the vertical integration rate or the appetite to do that.
Sure. So our appetite to do that continues. So we still want to move through the 80%. KapStone keeps us in that 74% range 74%, 73%, 74%, so we believe with the integration of the Victory tonnage so shipping more boxes into Victory keeps us mid 70%s and we will continue to look at opportunities to certainly grow organically with our expanded system and for bolt-on acquisitions that we can further integrate where it makes sense.
Great, thank you.
Your next question comes from the line of Mark Weintraub from Seaport Global Securities. Your line is open.
Thank you, and congrats on the KapStone, a couple of questions on the Consumer side, and you'd mentioned that the 50% affected by the PPW pricing and then there is some domestic stuff where you have other mechanisms and then you also added that export was perhaps done differently. Can you expand on that a little bit? How much of your Consumer business is export and what's happening in those markets?
Yes. Mark, it's Bob. Roughly about 25% to 30% of our business is outside of North America and much of that business is not linked to PPW. It would include business like tobacco and liquid packaging where we have long-term contracts associated with those pieces of business and they would typically run from one to four years.
Okay. And so how are they have been relatively stable?
I'm sorry, on the price side, I guess you – so you're getting hit by higher costs, but not necessarily because of the way the contracts are put in able to recoup it on the price side given the length of the contracts. Is that the way to think of it?
Yes. The contracts extend over one to four years and the mechanisms for pricing changes vary by contract.
Okay and then the one other thing again on the consumer side. On the one hand, when we look at the supply demand dynamics, it's looked like it's been very, very good. On the other hand, you do mention that it is very competitive. Can you help kind of align those two observations? Why do you think it's so especially competitive given that we're in an environment where I mean it would seem that the producers would be in a pretty good spot?
Well, it's always a competitive market. But maybe just to provide a little bit of context by grade, which might be helpful. The CRB and CNK portions of the market are tight and we've had good success realizing the previously published price increases for those portions of the business that are linked to PPW. CRB is more weighted to PPW and CNK and SPS are less than half linked to PPW.
In SPS were the previously published increases in the U.S. folding carton business, we're seeing those flow through in our business. Much of the remaining, as I mentioned, SPS business is really international business and in end markets that aren't linked to PPW and again those are tobacco, liquid packaging, and other portions of the business where we compete on a global basis.
Great, thank you.
Your next question comes from the line of Paul Quinn from RBC Capital Markets. Your line is open.
Yes. Thanks very much and great to see that you were finally able to get KapStone done.
Just a question on you highlighted the flexibility to be able to move capacity between kraft paper and containerboard. What specifically maybe you could talk to on a mill basis, where do you have that flexibility and how important will be that going forward? What's your opportunity there?
Hey, Paul, it's Jeff. So if you look at the mills, the combined mill system in Dublin, we have that ability today. Roanoke Rapids has that capability so does Tacoma and also Longview. So, it gives us optionality on line or medium or multiple kraft grades. So as we look at the demand profiles for our business, the customers' demand. We'll look to optimize the mills, the machines, the grades, the mix, the freight altogether. So that's the opportunity we have as a combined system.
Okay. And then just following up on the – I guess the opportunity at Victory. How much of that is embedded into the 2019 guidance?
Well, Victory we expect to have fully integrated in the fiscal 2019. So, we have 100,000 tonnes and we believe we can do that this fiscal year?
Great, that's all I had. Thanks a lot, guys.
Your next question comes from the line of Mark Connelly from Stephens. Your line is open.
Thanks. How substantial will the shift in sourcing for the West Coast customers in containerboard be? You've talked about replacing East Coast tonnes with West, but the KapStone system was running pretty full. So are you going to be turning away business out there to replace it with better business and is that in a big way? The second question is one of the benefits you cited from KapStone is increasing the Virgin ratio. Where does that mix stand in containerboard specifically?
Hey, Mark. So the containerboard will be 75/25 with the KapStone acquisition. And then on the West Coast, I wouldn't say that we would be turning away business. I think we're looking to optimize trades, our freights and looking for – we're always looking for opportunities to upgrade the mix, but I don't see us having to turn away customers to do that. I think that's just working with our trade partners, our plant and customer pairings; but I don't see us having to turn away customers to do that.
Okay. That's helpful. Thank you.
[Operator Instructions] Your next question comes from the line of Adam Josephson from KeyBanc. Your line is open.
Thanks. Good morning, everyone. Ward, just couple of questions, one on the CapEx guidance this year of $1.5 billion, do you have a sense of how much growth CapEx you'll spend in fiscal 2020 just at least based on what will bleed over from Florence and Tres Barras? And just more broadly on the growth CapEx issue, can you talk about what it's been on average historically?
So, let me talk about the strategic projects first and we've always given you somewhat the mix in our base CapEx. So on the strategic projects again we are across Florence, Porto Feliz, Mahrt, Covington, and Tres Barras. That's going to contribute about $500 million of CapEx in fiscal 2019. That number should drop to approximately half of that rate in fiscal 2020 because we'll just be at the tail end of Florence. This is a high investment year for Florence.
We'll invest about $100 million in Tres Barras this year and almost $200 million next year. But then the Porto Feliz, Mahrt, and Covington projects will be done as we exit this fiscal year. So the strategic projects' contribution should fall from $500 million to down to closer to $250 million for next year. And then we've talked about the fact that our base CapEx is allocated almost equivalently between return generating and maintenance projects.
Thanks Ward. And just on the inflation guidance, forgive me if I missed it, but I think you said $280 million to $300 million this year.
What was that number in fiscal 2018? And then you talked about OCC as well, I think being down $25 million or $5 a ton on average for fiscal 2019. When do you have OCC prices ticking back up in fiscal 2019?
They're fairly stable in the first half and then they start to tick up in the second half for fiscal 2019. If I look at our total inflation story for FY 2018, if you just tally up the bridges that we gave you every quarter for the full year, the inflation would have been approximately $240 million and what, that's remarkably the same as the guidance that we gave you at the beginning of the year.
But there was a lot of pretty dramatic swings in some of the key assumptions underneath it. Obviously we had the benefit from the decline in recycled fiber, but that was dramatically offset by or directly offset by the increases in chemicals and freight and logistics during the year.
So again in aggregate across all our cost categories including wage and benefits, all of our input cost, and transportation; it was approximately $240 million in FY 2018 and we are projecting it to be between $280 million and $300 million in FY 2019.
Thanks. And is just that KapStone adding to the number for 2019 so is it really different apples-to-apples, if you know what I mean?
No, it's not because – what we tried to give you was guidance of the KapStone contribution and then the price inflation assumptions across our base business. So it's an apples-to-apples comparison?
End of Q&A
There are no further questions at this time. I turn the call back over to the presenters.
Thank you, Marcella, and thank you to our audience for joining our call today. As always, reach out to us if you have any questions, we're happy to help. Have a great day.
This concludes today's conference call. You may now disconnect.