WestRock (WRK) Stock: Best In The Group; Will Become Evident In 2023

As we wrap up a challenging 2022, I felt compelled to revisit WestRock (NYSE:WRK), as it remains very cheap, and neglected by analysts and investors alike. As part of an oligopoly, concerns that the major players might behave irrationally have not played out. I believe WestRock has the best combination of improvable metrics, assets, and a solid management team that is currently being discounted. I have written extensively on WRK and for more details on the company and to see background, please see Prati Article on WRK.

The stock underperformance as seen below relative to Packaging Corporation of America (PKG) and the Materials Select Sector SPDR ETF (XLB) is unwarranted.

We are at an extremely interesting point in time when it comes to containerboard. The bear case has been completely wrong for many years now (based on new capacity-crushing earnings) but the bears have not given up. However, I believe they will do so fairly soon. The capacity that has been so greatly feared has mostly come on although there is a small part still hitting the market now. The reason the bear case has been wrong is that the players are doing what one would expect consolidated players in an oligopoly to do when there is more supply than demand – cut production to match supply with the lower level of demand.

(The divergence in the stock performance between WRK and PKG can be seen more dramatically in the longer-term chart below. I believe this divergence will reverse in 2023, as WRK improves its margins and cash flow and investors recognize that management execution and valuation deserve a re-rating.)

Demand has been soft due in part due to the economy (in part due to China lockdowns) but in part due to the inventory destocking cycle. Given that China is finally changing its Covid policy (even Xi has recently done a 180) underlying demand will accelerate from here, while the destocking cycle will be over in a few weeks. (WRK recently said on their call that order rates starting January 1 look much better and in line with underlying demand – so no more destocking.)

As demand accelerates and the last piece of supply has come on, there is no plausible incremental bear case likely to emerge at this point. Production will increase as the producers no longer need to take downtime. While the bears will point to the fact that pricing fell $20 bucks last month, this is not crushing earnings like many had anticipated because the price decline is tiny compared to the enormous decline in the industry’s input costs (OCC and to a lesser extent natural gas). Pricing could fall 5x as much as it has without impacting profits – that is how much cushion WestRock has from the dramatic drop in input prices. In terms of analyst favorite PKG, I think the perception from some analysts is that they have a better management team. This was fair and apt when the prior WestRock management team was in place.

But this is no longer the case now that WestRock has its new CEO, CFO as well as other executives that the new CEO has brought on board to the company. And now, the management team has been in place sufficiently long to put their operating plan into place and the results are beginning to show. When comparing the two companies, I think WRK’s portfolio deserves a higher valuation as 1/3 of the profits come from the faster-growing consumer packaging business. In addition, there is much more upside to containerboard earnings at WRK because all the historical acquisitions are finally being integrated by the new CEO, which will provide an incremental 40% upside to current earnings. Finally, while PKG has a slightly higher dividend yield, the dividend plus buyback yield is higher at WRK. One final point, WRK will release significantly more cash from working capital than PKG over the next 12 months.

My favorite ideas remain TSE in chemicals, PVH in retail and WRK in the packaging space. I also like HUN, Lanxess (OTCPK:LNXSF), DOW and OLN in chemicals, HeidelbergCement (OTCPK:HDELY), and CPRI as another top idea in high-end retail.