As we look through the rubble created by the relentless selling of value stocks since February, WestRock (NYSE:WRK) stands out as being particularly compelling. Not only because the valuation multiple has compressed to the lowest on record, despite lower leverage and better industry structure, but because the incessantly bearish narrative of the sell-side seems to be at stark odds with the recent sharply improved industry fundamentals. This is highlighted by the comments from leading industry consultant RISI this past week. After being bullish on WRK at $72 a few years ago, many of the sell-side analysts have been aggressively bearish on WRK over the last few years saying
1. Demand is going to slow
2. Financial leverage is too high
3. Management is not great and
4. There is too much supply coming on.
So far they have been dead wrong on
a. demand, as it has been stronger than they expected
b. the company, as it has reduced leverage significantly to a prudent level and
c. the management team, which has done a fine job generating a ton of cash in the process.
In addition, on point c, about management, the board recently hired a new CEO, a highly regarded senior executive from Sherwin-Williams (SHW) (a company that has always traded at a big premium valuation, currently at 40x EPS, not because there is much growth in paints but because it is so well run). Before joining WRK, the new CEO was the COO of SHW. It is worth noting that while at SHW, he oversaw the highly successful integration of SHW’s acquisition of Valspar, optimizing efficiency and reducing costs meaningfully. This quality demonstrated as a "hands-on" manager will come in quite handy at a company like WestRock that has done several large acquisitions over the last few years but has not fully integrated them.
In summary, despite three of the four legs to the bear case having fallen apart and the management point actually having become a positive, the multiple of WRK has gone from 7.5x EBITDA to 4.8x, its lowest on record. This valuation translates into a free cash flow yield north of 17%. Now to the last point of the bear case: supply additions. As the other arguments have fallen by the wayside, the sell-side has focused incessantly on this last argument, with a week rarely going by without one or more of them publishing reports pounding this argument. It goes like this, despite demand growing at mid-single digits over the last two years it is now supposed to grow at only 1.25% in 2022 and 2% in 2023 while supply will grow at 2.5% in 2022 and 2.5% in 2023. This implies that utilization will fall driving prices lower. I have pointed out in the past the issue with this argument is the following: Even if the bears are right regarding demand decelerating this much and supply coming on at the expected rate, pricing won’t fall because:
Now, let’s ignore my three arguments for a moment and focus on what the industry consultant (RISI) said this week since the sell-side treats them as the authority on containerboard and the backbone of their last bearish point of more supply than demand.
The World According to "RISI"-
(My Detailed Notes from a Conference Call with multiple investors and the RISI Consultant - My commentary in italics)
In summary, despite being wrong on the first three points of their bear case, when it comes to the fourth point, they cannot have their cake and eat it too. They uniformly treat RISI as the ultimate authority on the containerboard industry. If RISI is saying GLOBAL utilization will rise, then domestic utilization is not likely to fall much at all, let alone fall to below 90% where prices would come under pressure. It seems to be that the fourth and last point of the bear case is falling apart just as the valuation has hit an all-time low. In addition, we will know much more about the plan of the new CEO which should combine more aggressively buying back stock (now that leverage is down to the target level) and increasing profits through further integration of WRK’s acquisitions. It is just fascinating how WRK has hit an all-time low valuation when the entire bear case is broken and instead of trading at a 40% discount to its own history it should trade at a premium (like its European peers) as the secular tailwinds from ESG accelerate. Anyway, with this type of valuation, the uniform bearishness on the stock (now double accentuated by the heavy recent tax selling) the odds are quite skewed to the upside, to put it mildly.
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Disclosure: I/we have a beneficial long position in the shares of WRK either through stock ownership, options, or other derivatives. 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.