WestRock Company (WRK) CEO Steve Voorhees on Q3 2019 Results - Earnings Call Transcript

About: WestRock Company (WRK)
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Earning Call Audio

WestRock Company (NYSE:WRK) Q3 2019 Earnings Conference Call August 1, 2019 8:30 AM ET

Company Participants

James Armstrong - Vice President of Investor Relations

Steve Voorhees - Chief Executive Officer

Ward Dickson - Chief Financial Officer

Jeff Chalovich - Chief Commercial Officer & President of Corrugated Packaging

Pat Lindner - President of Consumer Packaging

Conference Call Participants

John Babcock - Bank of America

Brian Maguire - Goldman Sachs

Chip Dillon - Vertical Research Partners

John Rider - Stephens

Mark Weintraub - Seaport Global

Ketan Mamtora - BMO Capital Markets

Steve Chercover - D. A. Davidson

Edlain Rodriguez - UBS

George Staphos - Bank of America Merrill Lynch


Good morning. My name is Chris and I will be your conference operator today. At this time, I would like to welcome everyone to the WestRock Company Third Quarter 2019 Earnings Conference Call.

At this time, I would like to turn the call over to Mr. James Armstrong, Vice President of Investor Relations. You may begin your conference.

James Armstrong

Thank you, Chris. Good morning and thank you for joining our third quarter 2019 earnings call. We issued our press release this morning and posted the accompanying slide presentation to the Investor Relations section of our website. The release and presentation can be accessed at ir.westrock.com or via a link on the right side of the application you are using to view this webcast.

With me on today's call are WestRock's Chief Executive Officer, Steve Voorhees; our Chief Financial Officer, Ward Dickson; the Chief Commercial Officer and President of Corrugated Packaging, Jeff Chalovich; as well as our President of Consumer Packaging, Pat Lindner. Following our prepared comments, we will open up the call for a question-and-answer session.

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 filing with the SEC, including our 10-K for the fiscal year ended September 30, 2018. Additionally, we will be referencing non-GAAP financial measures during the call.

We have provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the appendix of the slide presentation. As mentioned previously the slide presentation is available on our website.

With that said, I'll now turn it over to you Steve.

Steve Voorhees

Thank you, James. Good morning. Thanks for joining our call this morning as we discuss our fiscal third quarter results and outlook. WestRock's net sales increased to $4.7 billion. This was 16% over last year. Adjusted segment EBITDA increased to $858 million. This is 14% over last year. Our adjusted segment EBITDA margin was 18.3%.

The WestRock team is performing extremely well as we proactively respond to a changing industry landscape, characterized by the challenges of additional new paper capacity, combined with softer demand in some markets. We see increasing opportunities for sustainable packaging, e-commerce packaging and value-added packaging solutions. We generated $749 million in adjusted operating cash flow during the quarter and we deployed $351 million of this cash flow in capital investments. This included $181 million invested in our strategic capital projects. We paid $117 million in dividends and we reduced our net debt by $282 million. Our net leverage at the end of the quarter was 2.95 times. Our pension plans remain fully funded.

Improvement in our financial results has been driven by the actions we have taken to grow our business organically by providing value-added solutions to our customers, improving our asset base through capital investment and simplifying our business to take advantage of our scale. I'll discuss the progress we're making in each of these areas during my comments.

Let's turn to slide 4. Adjusted segment EBITDA increased by $104 million. Setting aside the impact of KapStone, volumes declined primarily due to lower containerboard and paperboard shipments. We had favorable price and mix in both segments due to the flow-through of the previously published price increases. Our productivity improvements outpaced inflation. Inflation of $44 million was primarily due to wage and other cost. Higher wood and freight cost were essentially offset by the lower cost of recovered fiber.

We captured $47 million in productivity from the capital, synergy and other performance-improvement projects we've implemented over the past year. Economic downtime and scheduled consumer outages reduced EBITDA by $45 million and the KapStone acquisition contributed $152 million of year-over-year adjusted segment EBITDA improvement.

Corrugated Packaging segment sales, excluding recycling, increased 32% and adjusted segment EBITDA increased 28% as compared to the third quarter of fiscal 2018. North American corrugated adjusted segment EBITDA margins improved to 23.1%, up 110 basis points. This was the seventh consecutive quarter that we have reported North American corrugated adjusted segment EBITDA margins of 20% or more.

This sustained strong performance is a direct result of WestRock's Corrugated Packaging team's focused implementation of our differentiation strategy to help our customers win, all the while investing in the capital systems, processes and people to enable improvements in the quality and cost of our products across our integrated system. We reduced containerboard and kraft paper production by taking approximately 259,000 tons of downtime, including 94,000 tons attributable to planned maintenance and 165,000 tons of economic downtime. Our inventories at the end of June were 123,000 tons below March levels and 182,000 tons below the peak in December. Our inventory levels are now in our desired range of what we need to efficiently operate our system.

Our box volumes increased 20% on a per-day basis over last year. Our organic box volumes increased 2.7% due to our success in delivering customized solutions that enable our customers to win in their markets. Corrugated sales into distribution and e-commerce uses were up. We saw growth in packaged food. Agriculture shipments were down due to wet weather in the Western United States.

Our containerboard integration rate was 80% for the second consecutive quarter. You might recall, on our third quarter fiscal 2017 earnings call that we first articulated the goal to increase our integration to 80%. At that time, our integration rate was 72%. We have made substantial progress in just two years.

We are updating our integration rate target to reach 90% over the next several years. This provides us ample room to grow our box volumes, while serving our preferred domestic and export markets. The Florence paper machine project is well underway and the new machine is on schedule to start up during the first half of calendar 2020.

As a reminder, this project will replace three obsolete paper machines with a new state-of-the-art, low-cost paper machine that's optimally designed for today's and tomorrow's market requirements, producing lighter and better-performing kraft linerboard.

Brazil. Brazil's adjusted segment EBITDA margins for the quarter were 27.9%. The Porto Feliz box plant is running very well and ramping up production. Our Valinhos box plant is largely down. We'll have our grand opening of WestRock's largest and most technically advanced box plant in October. The Tres Barras mill upgrade project is well underway. Construction's on track and startup is scheduled for the first half of calendar 2021. The majority of the capital investment on this project will incur -- will occur in fiscal 2020.

The integration of KapStone has progressed exceptionally well. We are realizing our synergy and performance improvement targets ahead of schedule. We're at an annual rate of $80 million at the end of June and we expect to exceed our $200 million target by the end of fiscal '21. The pace of the KapStone integration is benefited from the investments we have made in our box and mill system over the past several years. Our scaled and simplified operating systems and regional structure have accelerated our integration activities.

Multiple KapStone box plants in the Longview mill have already transitioned to WestRock operating systems. We've internalized 71,000 tons of annualized box shipments through our Victory Packaging system. And we expect to achieve 100,000 annualized tons by the end of September. With the addition of KapStone, the scale, geographic reach, full range of containerboard and kraft paper grades and box-making technologies of our Corrugated Packaging network enables us to reliably and efficiently serve our customers throughout North America.

The Consumer Packaging business reported adjusted segment EBITDA of $233 million during a quarter in which we invested in three strategic capital projects at our mills that will improve margins and the long-term performance of the business. We realized price/mix improvements of $38 million and productivity improvements of $9 million.

Our backlogs remain at four to six weeks across SBS, CNK and CRB. We completed the major capital maintenance outages at Mahrt, Demopolis and Covington in the quarter. The Mahrt outage was completed early in the quarter and we are exceeding our project objectives for volume, quality and cost. We replaced the headbox at our Demopolis mill in June and this investment is also performing well. At Covington customer qualifications are in process and have gone very well to date.

The aggregate impact of these outages as well as regular maintenance outages at our other mills adversely affected our financial performance in the quarter by $22 million. The mill outages challenged our supply chain resulting in lower paperboard sales in the quarter, impacting EBITDA by an additional $16 million. Wood cost particularly at our Evadale mill remind -- remained elevated in the quarter due to the unusually wet weather in the region.

With the completion of these projects, we expect our supply chains to stabilize and see margin improvement during the current quarter. Converting shipments in Consumer Packaging increased 1.3% year-over-year. North American converting shipments increased 2.7% was partially offset by declines in Europe and Asia. Sustainable packaging and plastics replacements are generating significant market demand and interest.

We currently are working with dozens of customers on projects to replace plastics with fiber-based packaging. And we're currently at a $70 million run rate of incremental annual sales and we expect to reach a $100 million run rate by the end of this fiscal year.

We provide our customers with customized value-added solutions using the industry's broadest portfolio of paper and packaging solutions. This portfolio differentiates WestRock in the marketplace and enables us to help our customers lower their total costs, grow their sales, reduce the risk, and achieving their sustainability goals.

Our strategy of bringing our full suite of solutions to our customers is driving organic growth. 144 customers are buying more than $1 million of products and services from both our consumer and corrugated segments, accounting for approximately $6.8 billion of sales per year. These numbers represent more than a 40% improvement over the past three years.

We're enhancing the strength of our product and service offerings with the investments we're making in digital technology to automate customer experiences, simplify our processes and standardize our systems. A couple of examples include, the digital channel that many of our customers currently use to view and place orders and the advanced data analytics we use to anticipate unplanned downtime, reduce quality issues and minimize production variability.

We operate proprietary software that combines primary, secondary and tertiary packaging design to create packaging that minimizes waste and improves packaging performance for the benefit of our customers.

I want to take a few minutes to talk about the increase in SIOC packaging. SIOC is S-I-O-C Ships in Own Container. WestRock's comprehensive portfolio uniquely positions us to partner with customers to meet today's changing sustainable packaging mandates.

Amazon will soon require that all suppliers provide item -- that provide items, which are 18 by 14 by eight inches or larger used-packaging certified as ready-to-ship or face additional fees for packaging.

Using our integrated suite of products and working with our customers, we've developed solutions that create branded SIOC packages that meet these changing requirements.

A terrific example of our effort to develop SIOC solutions is our work with Colgate-Palmolive. In collaboration with Colgate, we created the SmileBox, which combines a folding carton manufactured by our joint-venture partner Grupo Gondi with Corrugated Packaging manufactured in our Winston-Salem facility to deliver an optimized branded SIOC package that's packed using WestRock machinery. The SmileBox has been very successful for Colgate. We're currently partnering with them on two dozen other SKUs for this type of packaging solution.

As consumers push for more sustainable packaging, ones that are recyclable, renewable and minimize material use, WestRock's comprehensive portfolio of fiber based packaging solutions enables us to meet these needs for our customers. Branded SIOC packaging provides our customers with an opportunity to further build their brand loyalty and recognition and improve their customer experience.

Our partnership with customers extends to helping them build a sustainable supply chain. We're working with our customers including U.S. Auto Parts on installing our Box On Demand machines to create custom sized boxes for their products.

This rightsizing of packaging, lowers packaging materials and shipping costs. Our packaging solutions lower our customers' total cost and help them meet the changing e-commerce and market requirements.

Now I'll turn over to Ward. Ward?

Ward Dickson

Thank you, Steve. Turning to slide 11. We outline our key assumptions for our fourth quarter guidance. We expect adjusted segment EBITDA in the fourth quarter to be between $880 million and $925 million. This compares to adjusted segment EBITDA of $858 million in our third fiscal quarter and $802 million in the last year's fourth fiscal quarter.

Sequentially higher seasonal volumes across both segments should more than -- should be more than offset by the flow through of previously published containerboard and kraft paper price declines and lower containerboard export prices. We expect sequential cost deflation driven by declines in virgin fiber costs, freight costs, recycled fiber and seasonally lower energy costs.

In addition, we expect to see material sequential gains due to lower scheduled mill outages and seasonal productivity improvements in the fourth quarter. We anticipate consumer packaging margins will improve over third quarter levels.

Depreciation, amortization and other items should be approximately $0.02 per share higher quarter-over-quarter and our tax rate in the fourth quarter should be consistent with our third quarter rate. We received $15 million in business interruption proceeds from the Panama City insurance claim in the third quarter and we expect to receive a similar amount in the fourth quarter.

Turning to our balance sheet. We remain committed to returning our long-term leverage ratio and generating significant free cash flow. We expect fiscal 2020 capital expenditures will decline to a level of approximately $1.1 billion, $300 million less than this year.

We also anticipate the capital expenditures will decrease $900 million to $1 billion in fiscal 2021. As we complete our strategic capital projects we remain committed to a stable and growing dividend and our primary use of free cash flow in the near-term will be debt reduction.

I'll now turn it back over to Steve for closing remarks.

Steve Voorhees

Thanks, Ward. WestRock team's performing extremely well as we proactively respond to a changing industry environment characterized by the challenges of additional new paper capacity combined with softer demand in some markets.

We see increasing opportunities for sustainable packaging, e-commerce packaging and value-added packaging solutions. We're growing organically by creating customized value-added solutions for our customers that support their needs to grow their sales, reduce their total costs and risks all while helping them achieve their sustainability goals.

We're investing in our business for the long-term to sustain and expand our competitive advantage. And we're building our systems and processes to take advantage of the scale of our platform.

We're moving from a period of a growth by acquisition, investment in large strategic projects and building the advantages of scale into our business to a period of increased focus on organic growth, innovation, productivity and free cash flow generation, a combination that will create value for our customers’, stockholders and teammates for the long term.

James, that completes my prepared remarks. We're ready for Q&A.

James Armstrong

Thank you, Steve. [Operator Instructions] Operator, can we please take our first question?

Question-and-Answer Session


Certainly. Your first question comes from the line of George Staphos with Bank of America. Your line is open.

John Babcock

Good morning. It's actually John Babcock on the line for George. Just starting out I was wondering if you could talk about – well, first of all, the early fiscal 4Q volume trends. And then earlier you also referenced getting your integration rate to 90%. And wanted to get a bit more color on how you expect to get there and if you can provide a little bit more detail on timeline of your input?

Jeff Chalovich

Sure. Good morning, John. It's Jeff Chalovich. So quarter-to-date starting on July our shipments are up about 5.4%. That's organic. If you take KapStone and then we're up a little bit over 23%. So part of the 5% came from early in the month -- prime day in some of our e-commerce shipments. So that's about one point of that 5.4% and then our Victory shipments contributed about 0.8% to that.

Overall, our backlogs are strong. They've ticked down a little bit from the first half, but they're in line with what we saw in both May and June months. And we finished 2.2% up in May and 4.4% in June. So I'm not expecting a 5% but our volumes and backlog's still strong through this month.

The strong markets -- we continue see strong markets certainly in e-commerce, bakery, snack foods. Ag started a little slow as we mentioned, but we're seeing pickup now with the better weather in the west and some of the northwest. Cherry season was decent and now apple. We're waiting we see some pickup there.

Now we continue to win basically with solution sales while we've shown the ability to grow organically. And if you look at how we've grown the last three years we're adding 180,000 to 200,000 tons a year to the converting system. So that will imply 4 to 5 years we can make that 90% integration rates. And we've shown the ability to do that over the past three years.

Now we have some great examples of our business growing what Steve mentions based on our differentiation. And so the solutions we're providing in supply chain optimization automation some of the Box on Demand that you saw solving problems in DIM weight taking costs out. We have some great examples of wins in the period in the quarter clearly that really show the benefit of solutions selling through the corrugated segment, but also the breadth of products we bring across the enterprise.

And I'll point out a few little large bakery customer that with our new Linkx acquisition we added $1 million of machinery based on our pellet sizing opportunity. So that's the BoxSizer. We had our first two sales of BoxSizer. We have about 40 customers in line of 40 machines in the queue that customers’ wants to talk to us about those. So we have an open house late in August where we have about two dozen customers looking at that business. But that's $5 million of sales wrapped up for five years, $5 million a year for five years.

Our merchandise display had their first machine sales through their group, $9 million of sales in equipment for a seven-year contract, $5 million a year or $35 million. We had an enterprise win, oatmeal customer that does breakfast foods, bags that go into a folding carton and those folding cartons go into a box. That was our first sale of machinery there, about $3 million in machinery and then $11 million of folding carton and boxes.

And then, Victory had their first machine sales through our APS group. We had $1 million in sales from machine, $1 million in Corrugated Packaging and $0.5 million in the consumables for a five-year. We're obviously seeing great lift in our retail-ready shelf-ready packaging through our graphics business. So all those things combined will help us to grow continually. And then, on the other side of the house, for our Machinery business, we have great things going on with consumer and plastic replacements and shrink. They're just augmenting and helping us grow. And I'd say, Pat if you want to comment on that piece.

Pat Lindner

Sure. Thanks, Jeff. Appreciate that. Well, first of all, a little bit on the quarter and how we're seeing the original question around the fourth quarter demand. In our volume trends, we still see pretty strong demand. I think year-over-year, we're probably flat, up slightly. But sequentially, we expect to be on track and up a little bit.

We are ramping up, as you'll see in our results from our three strategic outages in our mill system. We see strength in food service as well as in beverage and you'll also see from our results that our converting assets we're up about 2.7% in North America and that’s driven by food service and beverage largely and that continues into this quarter.

What Jeff was mentioning around some of the plastics replacements and we may get into this later, but this is a tremendous opportunity for our business and for our entire company. It's rare to see in an industry this type of, what I'll call, not-in-kind substitution. We're replacing material like plastic with paper and we're seeing this really ramp up. It hit a tipping point for our industry and this is really exciting.

A couple of the examples, or maybe one I'll just share right is -- and we talked about this last quarter briefly as an introduction, but we won some significant business with Diageo where they are replacing their plastic shrink wrap with a paper-based solution. It's our Cluster-Pak solution.

And to Jeff's earlier point around machinery, a key part of us winning this is our value proposition that we bring around machinery and producing -- and designing and producing a machine that operates at much faster rates, it's in the competitions. And along with that comes the carton business that's based on our CNK, our high strength and high wet strength CNK product.

So, that's a great example and there are others as well that we have. But that's a great example where we're taking machinery, combining it with our design around materials. And just in this quarter, the quarter reporting on, here in the third quarter we picked up two new machines, as they scale up, and the cartons associated with that. So we're really excited about the opportunity to leverage our full value proposition and our capabilities in driving the plastics-to-paper replacement efforts.

James Armstrong



Your next question comes from the line of Brian Maguire with Goldman Sachs. Your line is open.

Brian Maguire

Hi. Good morning everyone. Just a question on the CapEx outlook. I think late last year you were talking more like $1.25 billion for 2020 and some flow-through from growth projects into 2021 on a base of about $1 billion. And then, I think you lowered it in April to like $1 billion to $1.2 billion in 2020, maybe $1 billion in 2021. And now, looks like you're taking it down again to $1.1 billion next year, $900 million to $1 billion in 2021, if I heard you right.

Just wondering, what are the moving pieces there? Does that imply maybe that you don't think there'll be as much growth in the industry and you don't need to spend on projects? Or are you maybe just finding more savings and efficiencies in the projects and the spending that you're doing today?

And then just sort of tied into that, the comment around improving the integration to 90%, sort of, seems to imply some investment is needed in the downstream converting assets to kind of get there. Just wondering, if you think we'll just -- we might see some growth investment in that part of the business as some of the mill investment winds down. Thanks.

Ward Dickson

Okay, Brian. This is Ward. I'll start and then I'll have Jeff chime in on the converting investments. So you're right. This year we lowered our guidance to $1.4 billion. Embedded in that $1.4 billion, this was the peak year of our capital investments in our strategic projects. We'll invest over $500 million in the strategic projects.

Next year, as we move from FY 2019 to FY 2020, we've pinpointed FY 2020 now in the midpoint of the range that we previously gave you. We have just over $250 million, between $250 million and $275 million, that's targeted for the strategic capital projects next year. So the decline year-over-year is really being driven by the decline in the strategic projects.

I will say and as we've gotten into the KapStone assets, the integration of those assets, remember that we had set an ongoing CapEx level to support KapStone at approximately $150 million. We believe now with a better understanding of the assets that those investments are lower. So that's why we're confident in the – that we can both complete the strategic capital investments and continue to make investments inside of our system, to generate productivity and differentiation. As you know, we have invested substantially into our – over the last three to five years into our container network through the EVOL deployments. And so we have been modernizing that system and we're generating the benefits from those investments. Jeff, do you want to add anything to that?

Jeff Chalovich

Sure. Hey, Brian. So I'd tag along to what Ward said. One of the things we found as we looked at the projects in the KapStone queue for capital over a three and five year period they were heavy in these next five years on container on their converting assets. And they have between $30 million and $60 million in Greenfields coming up. Based on the scale of our system, we don't need to do that. We have invested well as Ward has said in the container systems. So we've built up the capability over the last five years to grow organically. And so on our normal capital rate we continue to do that. And we've been able to reallocate capital based on what we've seen in the KapStone. But it also showed that we have the ability to create a list of high return projects on assets. So we're going to continue to look through that through the system, but this year and into the next year some of the capital that needed for new box plants, we don't need to do that. And we're able to reduce the capital expense because of that.

Brian Maguire

Okay great. One follow-up on consumer if I could for Pat. Just any change to your pricing term? I know one of your big peers talked about shortening some of the lags and implementing pricing. Not sure, if that was as much of a priority for you or you're seeing any change in terms going forward.

Pat Lindner

Yeah. Thanks Brian for the question. And when it comes to pricing, of course, we can't comment on any forward-looking dynamics in the marketplace or plans that we might have. But when we look at the pricing in this specific question around lag in capture of previously published price increases, we look at it in terms of a number of different net mechanisms that we have. And as you know, we have a wide cross-section of different customers and markets. So we have pricing or contracts in terms of pricing that link pricing to PPW as well as open contracts and cost base indices.

So it's a little bit difficult to give you just one answer because of the complication associated with that, because it does vary so much across the customers in the markets. But I think as you can see from our results, over the last nine months we have realized about $100 million. Actually, it was a little over $100 million of flow-through from those previously published price increases. And in the third quarter alone, it was $30 million a year -- $38 million year-over-year. So we're confident in our ability to capture the gains associated with those previously published price increases, but it's a little bit complicated to give you an exact number, because of the different mechanisms that we have.

Brian Maguire

Okay. Thanks very much.


Your next question comes from the line of Chip Dillon with Vertical Research Partners. Your line is open.

Chip Dillon

Yes. Good morning. And thanks for all the details. If I look at your CapEx guidance just a quick question on this for the fiscal year that starts in three months – I'm sorry a year from three months from now the fiscal 2021 and I assume your DD&A saves at $1.53 billion that would suggest you would generate $2.25 billion of free cash flow, if you earn zero which is 6% of your stock price which means your free cash flow yield at zero earnings would be higher than almost all the rigid flexible packaging stocks. Could you just make sure my math is right? And also could you – do you have a thought as to whether that $900 million to $1 billion is sort of a sustainable level of CapEx that reflects modest growth projects in addition to maintenance?

Ward Dickson

So Chip, this is Ward. To be clear, we will generate a lot of free cash flow in this business. And that one of the levers that we have is we have been investing in these strategic projects. We will invest over $1 billion in these projects. And they are going to generate approximately $240 million worth of incremental EBITDA that will flow through to both earnings and cash flow generation for us. So we are comfortable that the ongoing level of strategic – base CapEx is going to be in that $900 million to $1 billion range. There is a small tail of the Três Barras mill in fiscal 2021. We have about $50 million to $60 million of capital that remains in FY 2021, and then the rest of it is our base CapEx that we're comfortable with. We do believe that the dividend yield and the free cash flow yield of WestRock is one of the compelling points of our valuation.

Chip Dillon

Okay. And just quick follow-up, when you look at the – that you were talking about the e-commerce impact of SIOC and you gave an example of the SmileBox. How do you think of some of the initiatives of making for frustration-free packaging that say Amazon is leading than others? How will the net impact of that be both on yourselves and the industry? I know, there are a lot of moving parts but are you seeing a reduction in corrugated demand because of this? Or is it slower growth? Or is it actually helping?

Jeff Chalovich

Hey Chip it's Jeff. Like you said it's -- there is a lot of moving parts. We are doing a considerable amount of testing for our customers for SIOC packaging. We have seen no degradation in our demand because of SIOC. It's -- I don't know if it will be a plus or a minus, but right now it hasn't degraded at all. We have seen more fallout in the smaller-box stuff from some of the envelopes and we are coming out with fiber-based envelopes from our consumer business and testing those as we speak in this quarter.

And we are looking at what we can do with our paper business also in some of the pouches. We also came out with a new machine that is making pouches out of fanfolds. So our pack on-demand will pack small from a 4x4, 6x6 up to a hoodie sweatshirt, a large bulky sweatshirt will help us compete in those markets and meet customers' demand in SIOC and also dim weight and shipment reductions. So, overall, we think we are well-poised to design, innovate around that. And when we help our customers win, I think, overall, that's good for us in the markets.

James Armstrong

Just as a reminder, please limit yourself to one question. Operator, can we have our next question please?


Certainly. Your next question comes from the line of Mark Connelly with Stephens. Your line is open.

John Rider

Hey good morning. This is actually John Rider on for Mark. So, question is if you could give us an update on the kraft paper business and if you expect pressure on plastics to have a material impact on that business over the two, three years? And just in terms of that if you could just give us a sense of which kraft paper markets are doing better than other?

Jeff Chalovich

Sure. So, I'll start at the high point of the kraft paper. It's our DuraSorb, so saturated kraft. Demand is strong in that market and if we can make it, we can sell it. The demand on the kraft paper in aggregate is a bit matching containerboard. I think there has been more pressure lately on the kraft-bag markets. The extensible market's more challenged and that was really because seeds, cements, fertilizer in the Midwest, our customers' producing for those who were affected by the floods. So, that's off a bit along with the kraft bag, but not -- it's not substantial. It's a few thousand tons from what we expected.

And overall I would say that if you looked at inventories and stock where we have seen destocking in the containerboard space, the kraft bag space is a bit different right now. And we see inventories higher in a bit of a slower destocking in our kraft sack business and the extensible is where we have seen more than our regular bag.

In the long-term, I think yes that we have opportunities through our customers with plastic replacements and opportunities in the sustainability realm. And as I said we're looking at pouches, envelopes, and other things we can use in our kraft space.


Your next question comes from the line of Mark Weintraub with Seaport Global. Your line is open.

Mark Weintraub

Thank you. First, I just wanted to clarify Jeff. So, when you were talking about July business, would you say that represents some pickup as one of your competitors suggests they were seeing? Or is it more kind of the same of what as what you had been seeing as another of the competitor had suggested?

Jeff Chalovich

It's a bit of a pickup Mark. Even without the prime and literally it's a bit of a pickup. If you look through the last quarter into this quarter, it's a pickup.

Mark Weintraub

Okay, great. And then I think that previously you told us a roughly 20% of your corrugated sales were now going through machinery-tied systems. Can you update us to what that might be now and where you think that could potentially go over? Any defined period of time?

Jeff Chalovich

Sure. We're over 30 now more getting towards 40 with associations of our machinery to our packaging. And as we continue to expand the machine business. That pull ratio will continue to also grow. So, as we look at driving our differentiation higher, that's a major pillar in our differentiation strategy and solving major challenges for our customers.

So, there's not a customer today we don't talk to that's not having labor challenges, efficiency challenges trying to streamline their observations and solve supply chain issues. So, with our ability of innovation design and then to marry that with our automation platform across our whole enterprise, we expect sales lift from that.

Mark Weintraub

Okay. Thanks. That sounds like a really big increase. Is that a big reason why you think you've been very successful in gaining share in the last year or two?

Jeff Chalovich

Yes, that's part of it. I think the other part is the design that goes with that the innovation and just the solution set. We are providing solutions for customers across a broad array and we're able to do that now with our folding carton business.

NPS is another one. So, I'll give you a great example we just had. They are in a horticulture space and their horticulture tags were going to be replaced with labels. They needed an automated solution to label the flower pots. And so in 90 days, we designed a machine with the supplier partner, produced the machine. We kept the labels, we got the labels. They are digital so a person can scan on the label without having a horticulture tag and sold four machines immediately. And there's great upside for that. So that type of ability in our system across the whole enterprise is a great way to differentiate and grow our sales.

Mark Weintraub

Thank you.


Your next question comes from the line of Ketan Mamtora with BMO Capital Markets. Your line is open.

Ketan Mamtora

Good morning. Can you remind us what is your integration level in Consumer Packaging? And has your view changed at all on kind of what level you need to be there in Consumer Packaging?

Pat Lindner

Yes. Thanks very much for the question. This is Pat. So our integration level overall is we consider to be about 60%. Let me describe a little bit of how that breaks down. In SBS we are a little bit over 50% integrated as a whole. About 20% of that goes through our folding carton business internally, so our internal conversion.

But that's a little bit understated because we have specialty applications such as tobacco, commercial print and a couple of other applications like liquid packaging where we consider those to be integrated because effectively we are specifying most of those downstream. So when you put all of that together we are actually in SBS about 55%.

In terms of CNK we are higher than that. We are at 70%. And CRB is about 60% a smaller part of our portfolio URB the uncoated recycle board is down around 30%. So overall net-net the weighted average of that is about 60% as an overall company. As far as your second question around are we happy with that and where it is we continue to look at this on an ongoing basis.

And our main priority right now is to -- as we drive integration and move that further to an integrated system, it's really all about organic growth for the plastics replacement opportunity and organic growth in general. But we see that as an opportunity to think about how do we strategic play in our markets and how we best serve our customers in those markets with our paper-based solution with again plastics replacements being one great opportunity.

That's not to say that we won't selectively explore inorganic opportunities but I think as you probably know there is -- other multiples in this space are still pretty high. And we've got to be very selective on deals that would look attractive to us. And so our focus right now is to drive organic growth as we look to in certain places to integrate or to increase our integration levels.

Ketan Mamtora

Thank you.


Your next question comes from the line of Steve Chercover with D. A. Davidson.

Steve Chercover

Good morning everyone. So first of all on the capital allocation priorities with respect to debt, I know you are still a touch above your target leverage ratio. But following the debt repayment in Q2 are you approaching a point where repurchasing stock might move up the pecking order in the capital allocation framework, considering you have got a 5% dividend that's probably up there -- commenced with some of your -- the coupons on your debt?

Steven Voorhees

That's a great question. I think that's something that we look at periodically. Just as the trade-off of that I think this past quarter we chose to pay down debt. But we will continue to look at over time. If you look at us over time we have done both.

And I think you've cited a couple of aspects that would make kind of share repurchase relatively more attractive. But I think this past quarter we were very comfortable paying down debt because I think from an enterprise standpoint our stockholders are getting the benefit of that almost dollar for dollar.

Steve Chercover

Yes. I agree. So I guess at some stage if you think that your equity is undervalued then it also makes sense to be front-end load it. And just a quick one on the KapStone synergies, they are continuing to accrue ahead of schedule. I know that you said you'll do better than $200 million which was the initial target. Is there a point where you are going to quantify how much more than $200 million you might be able to achieve?

Steve Voorhees

I think there won't be a point. I think our -- we'll get to $200 million and then we'll figure out how far we'll get past $200 million.

Steve Chercover

Okay. Thanks Steve.


Your next question comes from the line of Edlain Rodriguez with UBS. Your line is open.

Edlain Rodriguez

Thank you. Good morning guys. One quick one on Consumer Packaging, what's your outlook on at the SBS market which has been -- hasn't been as strong as the other grades? And also in terms of sustainability are you seeing similar trends in the U.S. as you are seeing in Europe in terms of shifting from plastics to paper-based packaging?

Pat Lindner

Yes. So thanks very much for the question. This is Pat. So, on the SBS market we actually see areas of pretty good growth. And as you know SBS is a pretty complicated one because of the broad market that it serves unlike some of the others which are a little bit more work focused in their markets.

So just looking at a couple of those segments, when you look at foodservice as an example foodservice is pretty strong right now and that's driven by sustainability, but I think it's also driven by just the trends in consumers today. There's a lot more interest in take-out and snacks and smaller meals rather than eating out with big meals.

And so a lot of our customers and retailers right now are looking to take advantage of that and offer packaging that helps service those needs and that demand. And many of those applications are moving towards to the extent they were in plastics they're moving towards paper more and more. That is the trend in North America. There's no question about that.

Now as far as other markets, certainly tobacco for SBS, certainly tobacco and commercial print continue to be in a secular decline, so that offsets some of those increases.

Now we're also pretty excited about what's happening in some of the plate markets as well as cup stock. The sustainability thing and this is one that's in Europe but also in North America to your other question, your second question is that SBS demand we think in the future could well be driven by some of the trends around sustainability around cup stock replacement.

And today those cups, for example, at Starbucks and others are polycoated so plastic coated on the inside. Now at WestRock, we can recycle that all the way through our entire system, our recycle system. But that's not true of many other recyclers in the industry. And so one of the things that we're doing there is that we're developing a fully recyclable coating and we recently won an award for that, the NextGen Cup Challenge. We won that and that was supported by a number of different companies like Starbucks and Coca-Cola and others. And so we're excited about that win.

We are in the process of customer trials. We’re scaling that up where we think if that turns and really if we can commercialize that there's over 650 billion cups -- paper cups used in the world. And so we think there's an opportunity there, obviously, to drive some SBS demand. But that's still a piece that's very much in development.

And just closing out on your North America versus Europe in terms of sustainability, I think Europe has been in the lead in some areas, certainly on the beverage side. I mentioned Diageo example where we picked up some nice business around shrink wrap replacement and there's others happening as well with other big retailers and other big brands.

North America has been a bit more focused on that foodservice side. We think beverage will come, but around plastics and different types of packaging when you look at aluminum cans in particular, North America has a pretty eclectic and diverse selection of different packages that are used. That will happen but that one's a little bit behind the trend in Europe specifically on beverage.

Edlain Rodriguez

Okay. Thank you very much.


Your next question comes from the line of Mark Weintraub with Seaport Global. Your line is open.

Mark Weintraub

Thank you. A question on the Florence facility for next year. How much -- given that a lot of that I assume is just going to be improved productivity and lower costs, how much is that project delivered just on that? So forgetting the small increment in capacity. But if we just focus on the improved cost position et cetera, can you give us a sense of that how big an impact that can be?

Jeff Chalovich

Sure. I think what we've said previously it's in the $60 million range.

Mark Weintraub

Okay. Thank you


Your next question comes from the line of George Staphos with Bank of America Merrill Lynch. Your line is open.

George Staphos

Actually I just want to quickly follow-up on SBS. I was just wondering if you can talk a little bit about, I mean so basically we had read about some supply changes in box for -- particularly in SBS. And so essentially wanted to get a sense for whether you're seeing an increase in demand associated with that?

Pat Lindner

Yeah. So SBS overall there has been a lot of changes in that market. And we can't comment other than some of the previously announced changes and additions and subtractions to the capacity that you've all seen.

I think going back to my earlier comment plastics replacements give us an opportunity to drive some increased SBS demand. I think its long-term direction is going to be dependent on the ability to capture some of those wins in plastics replacement.

The tobacco as well as the commercial print are offsets to that. So it's a little bit difficult to tell how all that is going to sort out, but right now what we see is we still have long backlogs in SBS. They're four to six weeks and maybe even on the upper end of that. We're ramping up from some of our production right now from the strategic outages to capture as much of that as we can.

So right now in the immediate term and right in the near-term it's really -- still pretty strong and pretty robust. But long-term I think depends on capturing some of these new innovative solutions that help solve some of the sustainability challenges particularly in the foodservice space.


[Operator Instructions] There are no further questions at this time. I turn the call back over to James Armstrong.

James Armstrong

Thank you, Chris and thank you to our audience for joining our call today. As always reach out to us if you have any questions. We are always happy to help. Have a great day.


This concludes today's conference call. You may now disconnect.