WestRock Company (WRK) is now trading at a significantly lower valuation than a year ago, despite showing strong revenue numbers across the board this past quarter and sporting a strong balance sheet. The KapStone (KS) acquisition last year was a good move to expand its physical presence as well as product offerings, but none of that seems to have convinced the market. The stock is now trading at about $35, or nearly 40% lower than its historical one-year high of +$56. Dividend yield at the current price stands in excess of 5%, making WRK worthy of consideration as a dividend investment. And, at the current price, there’s a considerable margin of safety as well. Let’s look at some of WRK’s key metrics to validate this thesis.
Why is the Stock Trading at Such Low Valuation Multiples?
From a relative valuation perspective, WestRock is trading at much lower levels than sector peers like Packaging Corporation of America (PKG) and Graphic Packaging Holding Company (GPK), which have respective forward earnings ratios of 12 and 15.3 compared to WRK’s ratio of 8.7. WRK is, however, trading slightly higher than the 7.2 forward earnings ratio of its larger competitor, International Paper Company (IP).
However, relatively weak earnings growth over the past few quarters since the acquisition as well as relatively weak guidance for Q4 2019 adjusted segment EBITDA have pushed forward earnings valuation down by nearly 7% on a YTD basis, while peers have largely gained value over that time. Q4 2019 guidance figures for adjusted segment EBITDA are between $880 and $925 million, or 9% at the lower end to 14.6% on the higher side on a year-over-year basis. That could be one reason the market isn’t ready to take WRK back to its pre-2019 levels.
Despite the weaker segment outlook for the next quarter, however, there are other factors that point to positive momentum in the medium term. For example, the KapStone acquisition has already generated $80 million in run-rate synergies as of Q3 2019, and the company expects that figure to hit $90 million in the next quarter and in excess of $200 million by FY 2021. But the market clearly thinks it’s not enough to offset the softer earnings growth predicted for the next quarter.
Downward Pressure: Warranted or Not?
There’s also still a lot of downward pressure from investor sentiment around macroeconomic factors, among which is the several months of decline in the U.S. manufacturing PMI:
What really spooked the market is the fact that this is the lowest level since September 2009, and that trend has continued through August 2019. Does that mean consumers are spending at 10-year lows as well?
That means general retail spending isn't likely to have been affected, implying that e-commerce is growing as well. The former is validated by this statistic from MarketplacePulse:
Source: Marketplace Pulse
What’s even more interesting is that Amazon (AMZN), unsurprisingly, is leading the eCommerce pack in terms of growth rate. Just look at its market share of the total U.S. e-commerce segment and the recent growth rate:
Source: Marketplace Pulse
The simple reason this statistic is significant is that Amazon sellers need packaging solutions, and WestRock is #2 in the business, second only to its larger peer, International Paper.
More to the point, there’s going to be a bigger need for SIOC packaging, or ships-in-own-container packaging, which is exactly what WestRock showcased as a major achievement for one of its customers, Colgate-Palmolive (CL):
Source: Q3 2019 Earnings Presentation
Why is all of this relevant to WestRock’s business? I’ll let WestRock CEO Steve Voorhees say it in his own words:
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.
Aside from smaller shippers selling on Amazon, which adds up to a lot of business, by the way, WestRock is also making gains with larger clients like Colgate-Palmolive, with whom they’re partnering on “two dozen other SKUs for this type of packaging solution.”
That means a strong revenue growth runway for the long term because consumer packaging represents more than a third of WestRock’s revenues.
Looking at the Dividends
In the meantime, dividend investors should definitely look at the +5% yield a little closer to see if there’s a measure of safety and sustainability, and an opportunity for dividend growth.
Factoring the KapStone acquisition, WRK’s net leverage ratio is currently close to 3x, but the company has reduced net debt by $282 million and is targeting a net leverage ratio of 2.25x to 2.5x. Net income after adjusting for non-controlling interests was $252.6 million, against dividend payments of $119 million for the third quarter. The dividend payout ratio is a shade under 50%, which is a lot better than the peak of 74% that it hit in Q4 2017.
At June 30, 2019, we had approximately $2.7 billion of availability under our committed credit facilities, primarily under our revolving credit facilities and Receivables Securitization Facility, the majority of which matures on July 1, 2022. This liquidity may be used to provide for ongoing working capital needs and for other general corporate purposes, including acquisitions, dividends and stock repurchases.
- 10-Q, Q3 2019.
The company has adequate means to keep paying dividends and increasing them over time. Since dividend payouts began in 2015 after the formation of WestRock from the merger of MeadWestvaco Corporation and Rock-Tenn Company, and the company has increased them every year. I don’t see that trend changing any time soon considering that the management is doing a good job of balancing debt and other obligations with investments in growth as well as returns to investors. No shares were repurchased this quarter (Q3 2019), but for the nine-month period ending June 30, 2019, the company has bought back about 1.7 million shares of common stock at an aggregate cost of about $101 million, with authorization open for another 19.1 million shares.
In my view, as long as a company is growing its top line and optimizing its margins while balancing financial obligations and investing back in the business, dividends are as safe as they can be. In WestRock’s case, not only are the dividends safe enough for any serious dividend investor to consider, but it might also suit the appetite of long-term investors looking for capital appreciation along with dividend returns and growth.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.