WestRock: More Upside Ahead

Summary

• WestRock is expected to report Q2 earnings on Wednesday, May 5.
• Given favorable demand/supply imbalances, WRK should enjoy accelerating earnings and cash flow in the years ahead.
• Shares remain attractive, particularly in the event of a sell-off.

Photo by imaginima/E+ via Getty Images

After pandemic-related challenges and a ransomware attack, WestRock (NYSE:WRK) has soared on the reflation trade, up about 140% since the lows of 2020. With governments firing housing stimulus and supply chain disruptions continuing unabated, input prices have been exploding. Since ecommerce never really slowed during the pandemic, but rather accelerated globally, containerboard demand has been doing well.

Wall Street has been more cautious on WRK, concerned that once stimulus measures slow that the economy could begin to unravel. Yes, that's definitely a long-term risk. Additionally, analysts continue to be worried about competitors ramping cardboard production in the short term, which may eventually hamper pricing.

So far, however, corrugated fiber/solid fiber box prices have been higher than the last peak recorded in 2018. Accordingly, WRK reported strong Q1 volumes, price increases, albeit about flat year-over-year Q1 net sales and EBITDA margins. Inflation served as a headwind to earnings, but these manufacturers will typically pass on the costs, i.e. it's only a temporary hit. Such costs were also mostly offset by productivity investments.

Executives across the industry generally view the market as substantially constrained and have identified sustained growth opportunities. WRK will execute, and as disclosed on pg. 45 on their Q1 earnings report, they've found incremental growth opportunities: "we expect to invest $800 million to $900 million in capital investments in fiscal 2021, which is higher than the estimates that we incorporated into the WestRock Pandemic Action Plan due to specific growth projects that we subsequently identified; that at these capital investment levels, we are confident that we will continue to invest in the appropriate safety, environmental and maintenance projects and complete our strategic mill projects while also making investments to support productivity and growth in our business."

Management has targeted capital to upgrade its cardboard mills to maximize on long-term growth and profitability, which should benefit EBITDA by $125 million in FY21, as disclosed on pg. 20 of its Q1 earnings presentation. I think once these investments are fully integrated and downtimes reduced, WRK will have dramatically better overall operating performance.

It's certainly difficult to gauge whether Q2 will print a beat or miss but the outlook remains constructive. Consensus shows revenue should sequentially increase by 2.2% and EPS has been kicked up to $1.01. Looking at external factors, U.S. retail and food sales just touched another record high in March, and still with lingering pent-up demand, there's probably longevity to these larger backlogs. Put another way, I think it's unreasonable to assume we're going to face an unforeseen cliff, and so the supply overshoot could ultimately be the higher probability, albeit lower impact factor.

Putting it all together, we're looking at a favorable industry picture combined with WRK's operational enhancement execution that will likely produce near-record earnings and cash flow in the coming years. Analysts have been slowly but surely revising estimates to reflect this developing reality:

Data by YCharts

This forecast works out to approximately 10x earnings, which although deservingly should trade at a discount with its cyclical behavior, values inexpensively to most corners in the market. Furthermore, TTM free cash flow came in at approximately $1.6 billion, and if you add in the aforementioned delta of improvements, the base of annualized cash flow can move somewhat higher too. Generally, I'd lean cautious using the recent print but others might point to the improving cash flow picture that would cut the multiple further.

In the near term, management has been focused on deleveraging the balance sheet but I wouldn't be surprised if capital return to shareholders picked up after realizing some headroom on leverage. Of course, they could raise the dividend yet if management believes the industry will stay red hot, buybacks would be the rational avenue. Plus, it would be a good vote of confidence. Management or analysts might consider bringing that discussion to the table in the back half of the year.

Bottom Line

Despite the massive share price run in WRK, I think there's still some gas left in the tank. The valuation isn't terribly cheap, but it's still reasonable given the favorable industry dynamics. Q2 will likely provide another decent print, and in the event of volatility, it will likely present an opportunity for those looking to capitalize on this massive, ongoing reflation trade. What do you think? Let me know in the comments section below.

As always, thank you for reading.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WRK over 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.