Investment Note: WestRock Looks Like a Bargain

Westrock Co. (NYSE:WRK) was formed in 2015 after a merger between predecessor companies MeadWestvaco and RockTenn. WestRock makes paper and cardboard packaging products, which are benefiting from the secular trend toward more sustainable and less polluting non-plastic packaging as well as the trend to e-commerce.

Westrock is an industry consolidator growing with acquisitions. Since its own formation, it has undertaken a long list of acquisitions and divestitures.

The company operates in two segments - Corrugated Packaging and Consumer Packaging. Though primarily concentrated in North America, it is expanding globally.

Since the formation of the present company in 2015, the stock is down from around $60 to ~ $30 per share, while operating cash flow per share has grown by a compounded 5% per year and Ebitda per share has grown by around by a compounded 7% per year. This divergence between fundamental performance and stock price trajectory has made the stock a compelling investment in my view, especially as I contemplate the end of recession and resumption of economic growth in 2021-22.

Balance sheet

The paper and packaging industry is a capital intensive business. Currently, Westrock has a capitalization ratio (Net Operating Income / ÷ Capital Deployed) of 16%, which is quite high. The following is a snapshot of WestRock's balance sheet.

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Debt numbers are moderate. The long-term-debt / ebitda ratio is less than 3.5. Interest Coverage (Operating Income / Interest Expense) is 3.06. WestRock's bonds are rated BBB and Baa2 by S&P and Moody's, and they trade above par showing no signs of distress.

The company paid ~$450 million in debt in the last quarter. According to my analysis, the company doesn't have major debt maturities until March 2022.

Deleveraging should lower the company's cost of capital further. Currently, I estimate the company's cost of debt is around 4.5%.

Growth

Westrock is growing mostly by acquisition, funded by debt. In the last five years, Westrock has grown Ebitda at a 17.1% Compounded Annual Growth Rate (CAGR) and Ebitda per share by a 7.2% CAGR (per share figures are lower due to share dilution). Total Assets have grown by a 13.8% CAGR in this period. I think these are good numbers in a mature industry, showing that Westrock management is a good operator and is creating value.

Cash flow

The following chart shows the various components of operating cash flow over the last five years. The business produces large amounts of free cash flow with a current cash flow yield (free cash-flow / market-cap) of 12.5%.

Dividend

Westrock recently cut its dividend in May 2020 by over 50% to focus on debt reduction. Its forward dividend yield is 2.64%. The dividend cut was aimed at prioritizing up to $1 billion in debt reduction over the next 18 months.

Valuation

The following valuation results were obtained by using the Gurufocus two-stage discounted cash flow calculator with the given assumptions. Note that even small changes in assumptions can result in large changes in valuation.

The company also looks undervalued in terms of the following ratios. However, the company in its present form is only five years old and has not gone through a recession, so the data below should be interpreted with caution.

The following table compares Westrock with its peers in the packaging and related industry. As you can see, Westrock's metrics compare favorably.

Conclusion

Based on these observations, I believe Westrock is selling at a very attractive price given its long term potential. The company faces strong economic headwinds due the pandemic induced recession and will likely stuggle in the next 12 to 18 months but should benefit strongly when the recovery takes hold.

I have a target of $50 for the stock to be achieved in three years. This, together with the dividend, should provide me with a projected return of 24% per year.

Disclosure: I own WestRock stock.

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