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Input Costs, Higher Maintenance Downtime Weigh on WestRock

Zacks Equity Research

We issued an updated research report on WestRock Company WRK on Feb 19. Cost inflation, higher maintenance downtime and rising interest expense may weigh on the company’s near-term results.


Mixed Q1


WestRock’s first-quarter fiscal 2019 adjusted earnings per share declined 5% on a year-over-year basis to 83 cents. However, total revenues rose 11% year over year to $4,327 million. The year-over-year improvement in total sales was primarily due to the increased sales in Corrugated Packaging segment, aided by the KapStone Acquisition and higher selling price/mix. However, the absence of recycling sales in the current year quarter and an unfavorable foreign currency impact somewhat offset sales. While earnings beat the Zacks Consensus Estimate, revenues missed the mark.


Tepid Q2 Ahead


WestRock projects adjusted segment EBITDA in the second quarter of fiscal 2019 to be between $700 million and $735 million, compared with $733 million reported in first-quarter fiscal 2019. The KapStone acquisition is likely to contribute $45-$50 million to adjusted segment EBITDA. Pricing will be higher by $10-$15 million in the Consumer Packaging segment as a result of previously announced price increases.


However, higher maintenance downtime and steps taken to reduce inventory to match demand is likely to dent results. Notably, maintenance downtime will be 88,000 tons in the second quarter fiscal 2019compared with 50,000 tons in the Corrugated Packaging segment in the first quarter fiscal 2019. In the Consumer Packaging segment, maintenance downtime will be 41,000 tons compared with 17,000 tons in the first quarter of fiscal 2019.


Further, wages and related taxes are anticipated to be sequentially higher by $45 million. Other input costs will be moderately higher, primarily owing to rising virgin fiber costs as a result of the wet weather. Higher acquisition-related depreciation and amortization and interest expenses is likely to lower earnings by 19 cents per share in the fiscal second quarter of 2019. Tax rate will also be higher at 24.5% compared with 23.3% in first-quarter fiscal 2019.


Cost, Maintenance Downtime to Dent 2019 Results


WestRock lowered adjusted EBITDA guidance for fiscal 2019 from $3.6 billion to $3.5 billion. In fiscal 2019, adjusted EBITDA will be affected by cost inflation, higher maintenance downtime. Higher D&A and interest expense will impact earnings per share in fiscal 2019. The company expects an adjusted tax rate of 24% to 25% for the fiscal.


In the Corrugated Packaging segment, the company ended up with approximately 100,000 tons of excess containerboard inventory following the KapStone acquisition. In the second quarter of fiscal 2019, the company plans to reduce inventories and match its production with demand. Maintenance outages in the mill system are scheduled to occur during the first three quarters of fiscal 2019 while no outages are scheduled for the fourth quarter. The mill maintenance downtime and actions taken to reduce inventory is likely to impact earnings in the second and third quarters of fiscal 2019. The segment’s maintenance downtime will be 272,000 tons in fiscal 2019 compared with 233,000 tons in fiscal 2018.


In the Consumer Packaging segment, the company expects to install a new curtain coater at Cottonton, AL mill in March 2019, upgrade one of three paper machines at Covington, VA mill in April 2019 and replace a headbox at its Demopolis, AL mill in June 2019. The downtime associated with these three projects will adversely impact earnings in the second and third quarters of fiscal 2019. Overall for the segment, maintenance downtime will be 121,000 tons in fiscal 2019, much higher than 47,000 tons in fiscal 2018.


Other Headwinds Ahead


The folding carton markets remain challenged by weak primary demand for processed, frozen, and dry foods. This is in line with the ongoing consumer preference for fresh foods and the shrinking center of the supermarket. Moreover, demand for carbonated drinks continues to remain weak, particularly in North America. WestRock operates in the highly cyclical pulp, containerboard and paperboard products industries. Unexpected fluctuations in prices of or demand for the company’s products can put pressure on profit margins, lower sales volume, and pose a risk to the company’s estimates.


Share Price Performance, Poor Valuation



In the last year, WestRock’s shares have fallen 39.7%, compared with the industry’s decline of 31.6%.


On a P/E (TTM) basis, the company's shares look overvalued compared with the industry with respective tallies of 9.7x and 8.6x in the last year.


The company currently carries a Zacks Rank #4 (Sell).


Some better-ranked stocks in the Basic Materials space are Ingevity Corporation NGVT, W.R. Grace & Co. GRA and Israel Chemicals Ltd. ICL. While Ingevity sports a Zacks Rank #1 (Strong Buy), W.R. Grace & Co. and Israel Chemicals carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.


Ingevity has expected earnings growth rate of 17.7% for 2019. The company’s shares have gained 57% in the past year.


W.R. Grace has expected earnings growth rate of 10.4% for 2019. Its shares have gained 14% in a year’s time.


Israel Chemicals has expected earnings growth rate of 10.8% for 2019. Its shares have rallied 32% in a year’s time.


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