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WestRock Bets on Favorable Demand Amid Higher Transport Costs

On Sep 7, we issued an updated research report on WestRock Company WRK. The company’s pending acquisition of KapStone Paper and Packaging Corp. KS, once complete, will likely generate significant cost synergies and broaden the company’s paper packaging product offering. In 2018, favorable demand, price and mix trends across paper and packaging businesses will drive the company's fiscal 2018 results despite higher transportation costs.
Sound Fiscal 2018 Anticipated Despite Inflated Costs
The company anticipates fourth-quarter fiscal 2018 adjusted earnings per share to improve significantly from third quarter's adjusted EPS of $1.09. Lower maintenance downtime along with sales price increases, seasonally higher volumes, favorable mix and continued productivity gains will lead to sequential rise of $68 million to $83 million in adjusted EBITDA.
Transportation costs have been high lately and are expected to persist in the near term. Overall, input costs are projected to be in the range of $10 million to $15 million higher than the third quarter. Adjusted EPS in fourth-quarter fiscal 2018 will also be negatively impacted by a higher expected tax rate, and higher depreciation and amortization.
The Zacks Consensus Estimate for fourth-quarter fiscal 2018 is pegged at $1.26, reflecting year-over-year growth of 45%.
WestRock is benefiting from favorable demand, price and mix trends across its paper and packaging businesses. The company projects revenues of around $16.3 billion and adjusted segment EBITDA to come in above $2.9 billion in fiscal 2018. Adjusted EBITDA margins are likely to increase by more than 250 basis points year over year to approximately 18%.
The Zacks Consensus Estimate for fiscal 2018 is $4.06 (55% year-over-year growth) on the back of revenues of $16.3 billion (10% year-over-year growth).
Productivity Improvements to Aid Results
WestRock was formed by the merger of MeadWestvaco and Rock-Tenn in July 2015. The company is realizing the strategic benefits of the merger. In third-quarter fiscal 2018, the company achieved its $1-billion target for synergy and performance improvements. This was achieved by the productivity and performance improvement programs across its manufacturing footprint as well as cost savings from capital investments. Further, manufacturing optimization and reductions from the elimination of duplicate corporate costs and support functions will drive results.
KapStone Buyout to Enhance Presence & Product Portfolio
WestRock previously announced that it will acquire all the outstanding shares of rival KapStone at $35 per share and the assumption of approximately $1.36 billion in net debt, for enterprise value of approximately $4.9 billion. The buyout is expected to conclude by the end of 2018, subject to customary closing conditions. On conclusion, it is anticipated to be accretive immediately to the company's adjusted earnings as well as cash flow. It is projected to lead to around $200 million of annual cost synergies and performance improvements, with half of it likely to be realized within first 12 months.
KapStone's corrugated packaging operations will enhance WestRock's North American corrugated packaging business. It will help strengthen presence in western United States and compete better in the growing agricultural markets in the region. The company will also be able to broaden its portfolio of paper grades, allowing it to capitalize on the kraft bag market with the inclusion of KapStone's complementary specialty kraft paper offerings.
Higher Debt to Fund Deal
WestRock plans to fund the cash portion of the KapStone deal through new debt and refinance KapStone's assumed debts at the closure of the deal. Higher interest expenses will affect margins.
WestRock has underperformed the industry with respect to price performance over the past year. The stock has dipped 4.8%, while the industry has recorded growth of 7.8%.
Zacks Rank & Stocks to Consider
WestRock currently has a Zacks Rank #3 (Hold).
Some better-ranked stocks in the same sector include Ingevity Corp. NGVT and CF Industries Holdings, Inc. CF. While Ingevity sports a Zacks Rank #1 (Strong Buy), CF Industries Holdings carries a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank stocks here.
Ingevity has a long-term earnings growth rate of 12%. The stock has appreciated 63% in a year’s time.
CF Industries Holdings has a long-term earnings growth rate of 6%. The stock has gained 58% in a year’s time.
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