Is WRK a smart choice in a sector that is gaining institutional favor?

November 19, 2018

Is WRK a smart choice in a sector that is gaining institutional favor?

The month of October put investors on notice that volatility in the stock market wasn’t going to go away anytime soon. I think it makes sense; investors are becoming more and more aware of the difficulty associated with extending an unprecedented period of economic expansion. I think they’re also starting to realize the kind of balancing act the Federal Reserve has been playing, since interest rates remain historically low despite the fact that rates have been rising gradually since late 2015. The Fed has long been trying to facilitate the proverbial “Goldilocks” scenario – economic growth that isn’t too hot, nor too cold, but just right. Will they pull it off, or will the economy start to heat up to the point that the Fed is forced to raise rates faster than they have been doing? Given how sensitive the market has been to any kind of negative-sounding rumor about interest rates for more than a decade, it really shouldn’t be surprising that interest rates continue to be capable of driving the markets to big swings at any given point.

Trade tensions, which have continued to be an ongoing question now for so many months that I think investors are getting weary of hearing about it, continue to weigh on the markets. I think one of the biggest concerns investors have right now is that the effects of tariffs on China in particular, and America’s other trading partners will finally be the straw that broke the camel’s back on the current bull market. More and more corporations are starting to discuss tariff risks openly during their quarterly investor conference calls; and in more and more cases, they aren’t talking about them as potential risks in quarters ahead, but as factors that are forcing management teams to rethink their strategy and adjust their business models, right now. It certainly seems that investors are desperate for any shred of positive news on the trade front; earlier this week the mere suggestion that a Chinese diplomat had reached out to the Trump administration to start setting the stage for a meeting between the Trump administration and China’s premiere about trade gave the market a nice one-day jump.



These are two of the big factors that drove the broad market into correction territory through the end of October, and a lot of stocks down past correction levels and into their own bear market ranges. On a sector basis, the Materials sector was one of the hardest hit; from its January high point until the end of October, the sector dropped by about 22% as measured by the S&P 500 Materials Sector SPDR ETF (XLB). While the market has struggled to find its footing since that point – it rallied briefly in the first week of the month but has dropped back almost to its October 31 low – this sector has rallied a little over 10%, which is an indication that institutional investors could be gravitating into a sector that provides a lot of the raw, unfinished goods that the rest of the economy uses.

Over the years, I’ve developed an appreciation for companies in sectors like Materials; I think of them in similar terms as the entrepreneurs that gravitated to California during the Gold Rush, but instead of mining for gold themselves, sold the pickaxes, shovels, wheelbarrows, and other equipment to the hordes of desperate miners that were rushing into the hills. These are companies whose businesses can be highly cyclical and sensitive to economic changes, which means that at the top of an economic cycle, risk could be elevated. The truth, however is that despite the concerns i listed above, economic growth continues to be pretty robust and healthy. In the meantime, this year’s volatility has pushed the Materials sector to levels that have created some pretty interesting individualized value proposition. One of those is in WestRock Co. (WRK), a company that operates in the Containers & Packaging industry.



Fundamental and Value Profile

WestRock Company, incorporated on March 6, 2015, is a multinational provider of paper and packaging solutions for consumer and corrugated packaging markets. The Company also develops real estate in the Charleston, South Carolina region. The Company’s segments include Corrugated Packaging, Consumer Packaging, and Land and Development. The Corrugated Packaging segment consists of its containerboard mill and corrugated packaging operations, as well as its recycling operations. The Consumer Packaging segment consists of consumer mills, folding carton, beverage, merchandising displays, and partition operations. The Land and Development segment is engaged in the development and sale of real estate primarily in Charleston, South Carolina. WRK has a current market cap of $11.8 billion.

  • Earnings and Sales Growth: Over the past year, earnings increased a little more than 48%, while sales improved about 4.5%. Growing earnings faster than sales is hard to do, and generally isn’t sustainable in the long term, but it is also a positive mark of management’s ability to maximize its business operations. In the last quarter, earnings increased about 18%, and sales grew by 2.4%. The company operates with a margin profile that narrowed significantly from 11.7% in the past twelve months to 6.59% over the last quarter.
  • Free Cash Flow: WRK’s Free Cash Flow is healthy and robust, at $1.4 billion, and which translates to an attractive Free Cash Flow Yield of 12.2%.
  • Debt to Equity: WRK has a debt/equity ratio of .49, which is pretty conservative and indicates the company has a disciplined approach to debt management. The company doesn’t have great liquidity, with cash and liquid assets of a little over $452 million in the last quarter versus long-term debt of more than $5.6 billion; however their balance sheet indicates that operating profits are more than sufficient to service the debt they carry. A large portion of their debt can be tied to the acquisition of KapStone Paper and Packaging earlier this month – a deal that carried an enterprise value of $4.8 billion.
  • Dividend: WRK pays an annual dividend of $1.82 per share, which at its current price translates to a very attractive dividend yield of about 3.94%. The passive income the stock’s fat dividend offers could be a compelling factor to consider for holding the stock and letting the price work through whatever market conditions do to the stock in the long term.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for WRK is $45.01 per share. At the stock’s current price, that translates to a Price/Book Ratio of 1.02. The stock’s historical Price/Book ratio by comparison is 1.52 and puts the top end of the stock’s long-term price target at almost $69 per share. The stock’s Price/Cash Flow ratio provides a somewhat more conservative view, since the stock is currently trading about 33% below its historical average. Even so, that puts the stock’s long-term target price between $61 to $69 per share – which is pretty compelling right now even if you think the market could be overdue tor a major bearish downturn.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: WRK’s downward trend since late January is easy to see. That trend accelerated in a big way in early October as the stock broke down below support around $54 and plunged to a new 52-week low at around $30 per share. That was a decline of more than 43% over that period, and nearly 28% in just a couple of weeks. From that point, the stock has rallied almost 18% over the last couple of weeks as the sector has rotated into favor, but is still well below the $54 level that I think the stock would need to push above to mark a reversal of that downward trend. If the market turns strongly negative again, and pulls the sector with it, a drop below $39 would mark a continuation of that downward trend, with the stock’s multi-year low around $27 not out of the question.
  • Near-term Keys: If you want to be aggressive, the stock’s bullish momentum, along with generally bullish sentiment associated with the Materials sector could provide a tailwind for a short-term bullish swing trade if you want to buy the stock or work with call options. In that case, you should think about the range between $50 and $54 as a pretty reasonable short-term price target. If the stock breaks down below $44, it should retest the $39 level pretty quickly, and that could be an interesting opportunity to think about shorting the stock or buying put options. Keep in mind, these are aggressive short-term trades. Given the value proposition the stock is offering right now, and the generally positive fundamental profile – including a very attractive dividend – I think the best opportunity lies in the long term. It certainly isn’t a given the stock is done dropping, but it already offers a very interesting bargain. If you don’t mind being patient, and letting the stock work through some price volatility in the weeks or even months ahead, this looks like the kind of stock that value investors are hungry to find in any market.