WRKCo Won’t Package Growth As You Expect

The Company in a Nutshell

• WRK expects to achieve $200M in synergies by the end of fiscal 2021 through the integration of KapStone.
• 63% of WRK sales come from corrugated packaging, 37% from consumer packaging.
• Don’t think for a minute that corrugated packaging is a growth business.
• The industry is going toward an oligopoly to maintain high prices and strong margins.

I’ve worked from home for over a year now. When something happens in my neighborhood, I’m always among the first guys to notice. What I’ve seen so far is an increase of Purolator, FedEx and UPS trucks going back and forth. With the rising of online shipments, it seems there is business for everyone in the delivery business.

In the search for new investment opportunities, some readers brought to my attention that those who make boxes should benefit from the same tailwind. After all, everything that is being shipped needs a box, right? Therefore, how does a leader such as WestRock (now WRKCo) (WRK) see its stock plummet lately?

Source: Ycharts

Is it the right timing to buy WRK, or is this drop just the sign the business isn’t doing so well after all? Let’s dig further to see what we find!

Business Model

WestRock Co, the result of a merger between RockTenn and MeadWestvaco, provides paper and packaging solutions in consumer and corrugated markets. The Company offers corrugated containers, paperboard, partitions and protective packaging, containerboard and beverage multipacks. The company employs more than 45,000 workers in its 300 facilities across the world. In November 2018, WRK completed the acquisition of a smaller rival, Kapstone, for $3.5B. Considering this transaction, WRK will now show over $20B in sales per year.

Source: WestRock August Investors Presentation

Growth Vectors

Source: Ycharts

As you can see on the previous graph, WRK is growing its revenue by waves. The company has jumped in the growth by acquisition strategic train, and each transaction leads to a revenue jump. This helped WRK become a leader in this industry with International Paper (IP) and Packaging Corp. of America (PKG). Together, they created an oligopoly, and they make sure to sustain high margins so there is money to be made for everybody.

Going forward, WRK will continue to grow its business by acquiring smaller competitors. Management expects to generate synergies from those transactions. We clearly see the amount of plant production decreasing as the consolidation in this industry goes on:

Source: Packaging Strategies

WRK will then benefit from strong barriers to entry as it will be difficult to produce the same amount of corrugated boxes at a similar lower price than WRK. This is how WestRock should continue to surf on strong margins going forward.

Potential Risks

Through several acquisitions and the creation of an oligopoly, higher margins have already been put in place. There is now limited room for margin expansion. The same situation is valid for further acquisitions. After this wave of consolidation, next acquisition targets will become more expensive, and synergies will likely not justify their price. Increases in freight, raw material and wage costs may also affect WRK margins going further.

While you think corrugated packaging is a buzz word that will generate growth for the next decade, facts point toward to another direction. The packaging business is doing okay, and it is growing. However, we are talking about a low single digit growth.

Source: Packaging Strategies

Since the business won’t be growing fast in the upcoming years, it will be difficult to find other growth vectors.

Dividend Growth Perspective

WRK has become a steady dividend payer with a decent growth history. Through several acquisitions, WRK has been able to generate lots of cash flow and reward their shareholders. WestRock is even part of our consumer dividend stock list.

The company shows an impressive 5-year dividend growth rate, but this was mostly linked to a big dividend jump in 2015. Going forward, we think shareholders should expect a mid-single digit dividend growth rate. Payout ratios are low, but there is limited amount of growth vectors at the moment.

WRK meets our  7 dividend growth investing principles.

Valuation

After the recent stock price drop, it’s only normal if investors wonder if there is a buy opportunity here or if its just a falling knife. When we look at the PE history, we notice WRK isn’t trading at expensive multiples.

Source: Ycharts

We also used the dividend discount model with moderate growth numbers to see if it would make sense to buy WRK for its dividend potential. We obviously used smaller growth numbers than WestRock’s dividend history. This is because we think the company will have a hard time growing through acquisition in the future, and margins could be under pressure.

Please read the Dividend Discount Model limitations to fully understand my calculations.

Unfortunately, there isn’t an obvious deal here. Shares still seem a bit overvalued, but please consider we have used very low numbers for our dividend growth rates.

Final Thoughts

While you may think that corrugated packaging is a fast-growing business due to the impressive load of shipments coming from e-commerce, you are wrong. In fact, global paper consumption is slowing down and there isn’t growth coming from food and drink packaging (as plastic is taking lots of room too). Therefore, an investment in WRK is not to surf on a strong tailwind. The company enjoys higher margins as there are limited competitors, and they all agree to keep prices up. International Paper, WestRock, and Packaging Corp. of America will continue to dominate this market for years. You can see WRK more like a bond that will slowly grow in time while paying a healthy dividend.

How’s waiting working for you?

Investing when the market is high is not a simple task. You may think you found the right company, but the stock is clearly overvalued. Therefore, you wait until the market offers you an opportunity.

Last year, I didn’t hesitate to invest over $100K in the market. I did it while the market was at an all-time high.

I didn’t blink. I didn’t flinch. Do you know why? Because I know something. A truth. The simple truth of investing: Five years from now, those companies will trade at a higher price.

I’d like to tell you more about my investing methodology by sharing with you my top five stocks to hold for the next five years. Therefore, you won’t have to wonder if they will drop in the next six months – you will lock them in for a long period of time. Join me at my webinar and I’ll share not only five US dividend stocks I like, but five Canadian ones, too!

Click here to register to the webinar (email required)

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Disclaimer: We do not hold SYF in our Dividend Stocks Rock portfolios.

Featured Image Source: Pixabay