Pulp and paper leader WestRock (WRK 0.81%) acquired peer KapStone to bolster its presence in the coveted, albeit somewhat boring, world of cardboard. It's been paying off handsomely for the business and shareholders -- and the majority of targeted cost savings have yet to be delivered.
KapStone alone contributed a $151 million year-over-year increase in adjusted segment EBITDA in fiscal second-quarter 2019. WestRock also delivered strong year-over-year revenue growth, demonstrated intelligent management of production volumes, and announced the completion of the first major capital project aimed at driving long-term earnings growth. Here are the main takeaways from the company's fiscal second-quarter 2019 earnings report.
Image source: Getty Images.
By the numbers
WestRock reports two operating segments: corrugated packaging (cardboard boxes and the like) and consumer packaging (containers for food, electronics, and the like). A rising global middle class population and increasing e-commerce sales in North America have led to healthy margins for the former in recent years. Expectations for the trend to remain in place for the foreseeable future also prompted management to pull the trigger on the $4.9 billion acquisition of KapStone, which focused primarily on corrugated products.
The business clearly benefited from the acquisition, which formally closed in the beginning of November 2018. WestRock's corrugated packaging segment outpaced both revenue and earnings gains for the business compared to the year-ago period. Impressively, that's true even after accounting for a $28 million hit to adjusted EBITDA from "economic downtime" as the company curtailed production volumes to better align with demand from customers. It was more of a temporary way to manage inventory levels than an alarming deterioration in market fundamentals.
|
Metric |
Fiscal Q2 2019 |
Fiscal Q2 2018 |
Year-over-Year Change |
|---|---|---|---|
|
Corrugated packaging revenue |
$2.89 billion |
$2.27 billion |
27% |
|
Consumer packaging revenue |
$1.67 billion |
$1.64 billion |
2% |
|
Total revenue |
$4.52 billion |
$3.91 billion |
16% |
|
Corrugated packaging operating income |
$310.3 million |
$262.8 million |
18% |
|
Consumer packaging operating income |
$85.2 million |
$94.6 million |
(10%) |
|
Total operating income |
$396.0 million |
$373.5 million |
6% |
|
Adjusted segment EBITDA |
$757.1 million |
$649.2 million |
17% |
Data source: Press release.
The segment contributions weren't quite as lopsided as a quick glance at the numbers suggests, however. WestRock took a $14 million hit to adjusted EBITDA for its consumer packaging segment related to a production outage at the Mahrt mill while it installed new equipment for applying coatings to paper products.
It's part of a wave of capital projects aimed at modernizing the manufacturing fleet. Management estimates that projects completed in fiscal 2019 will drive a $15 million annualized improvement to segment EBITDA. That will swell to a combined $80 million by the end of fiscal 2020, and a combined $150 million by the end of fiscal 2021, equivalent to a roughly 5% improvement from last year's EBITDA total.
WestRock also reported that it has achieved $70 million in annualized cost-savings related to the KapStone merger. It expects to end fiscal 2019 at a $90 million run-rate and deliver the full $200 million annualized target by the end of fiscal 2021. The sources of the savings are relatively balanced between operating efficiency, administrative efficiency, supply chain optimization, and procurement improvements. That should provide confidence that the business can succeed, despite the fact many synergy targets from major mergers fail to materialize.
Image source: Getty Images.
Looking ahead
The pulp and paper leader expects to benefit from seasonal trends in the fiscal third quarter of 2019. Adjusted segment EBITDA is expected to rise to roughly $850 million on the heels of improving volume, mix, and cost deflation (primarily from lower fiber and energy input costs). WestRock expects full-year adjusted segment EBITDA in the neighborhood of $3.35 billion, up significantly from $2.89 billion in fiscal 2018 and $2.29 billion the previous year.
While the KapStone acquisition will remain a significant driver for growth, it's not the only contributor. Increasing operating efficiency, production volumes, and selling prices are expected to provide a shot in the arm, as is the company's focus on convincing existing customers to switch from plastic to paper as their preferred packaging solution -- for instance, beverages traditionally sold with shrink-wrap or plastic rings can be replaced by certain grades of fiber-based packaging.
The efforts are paying off. WestRock has increased the number of customers purchasing more than $1 million of products from both of its segments from 102 at the end of fiscal 2016 to 143 at the end of its fiscal second quarter of 2019. That may not seem like much, but those customers are responsible for $6 billion in annual sales, up from just $4.7 billion at the beginning of the tracking period. The trend suggests the company's fate isn't entirely tied to trade wars or factors outside of its control.
A solid business on a solid trajectory
Wall Street has largely ignored the company's progress in the last 12 months or so, but that doesn't mean individual investors have to. WestRock is on solid financial footing and exploiting multiple growth opportunities, from rising demand for corrugated packaging to organic sales from existing customers. Yet somehow the stock trades at just 0.84 times book value, a PEG ratio of 0.60, and sports an annualized dividend yield of 4.7%. If the key to building wealth is buying great companies and holding on for the long haul, then investors should give a hard look at this industry leader.
