WRK - WestRock: Disappointing Guidance

Summary

• Client inventory levels (with lower demand) and adverse weather negatively impacted WestRock's Q1 financials.
• Our Plastic to Paper thesis is still on. The packaging division delivered another solid quarter.
• WestRock removed the full-year guidance and FCF was further reduced. We confirm our buy rating, lowering the company's target price.

After having analyzed International Paper ( IP ) Q4 and FY numbers, today we are back to comment on WestRock ( WRK ). Following IP's stock price development (yesterday, the company was up by more than 10%), WestRock is now at -15%. So, what is going on?

• WestRock decided to remove its full-year guidance. This was not well received by Wall Street analysts. During the Q&A, the company's CEO was transparent and disclosed that the packaging business is well on track with internal estimates, while the global paper division is the biggest headwind;
• Still related to the guidance, FCF was lower than expected. This was due to higher CAPEX requirements and was mainly driven by supply chain constraints and postponed investment from last year;
• Volume in the global paper division was the main weakness in the quarter;
• Another negative trend is the lower export that the company is expecting. As a reminder, containerboard output is 75% domestic and the remaining part is dedicated to export;
• Client inventory levels in the corrugated division are normalizing, while in the containerboard, warehouse inventory is still behind. There is soft consumer demand and the macroeconomic outlook is not the greatest;
• As a one-off negative event, adverse weather conditions led to a minus $119 million fully recorded in the quarter. Other not positive expenses were a minus $17 million related to unfavorable FX evolution and non-cash related, there is a cost increase in the pension scheme for $40 million.

During Mare Evidence Lab's initiation of coverage called WestRock - It's Getting Better All The Time , we were forecasting further price increases over raw material inflationary pressure. This positive trend was also confirmed at WestRock's investor day. If we are adjusting for the lower volumes, WestRock is still managing its cost pressure pretty well.

Source: WestRock Q1 Results

Important note to add:

1. Q1 margins are historically lower versus the full-year picture;
2. Maintenance downtime is in line with the company track record;
3. WestRock order backlog is pretty strong and was confirmed by the CEO in the Q&A analyst call;
4. The natural gas price is down 20% and now is hedged at $5.00/MMBTU;
5. Management is committed to 2025 financial targets with the aim to achieve a 20% EBITDA margin both in the corrugated and consumer segment.

Conclusion and Valuation

Despite the positive above points, the company's total debt is up by $1.7 billion in the 2023 first quarter, this is related to the Grupo Gondi acquisition. Lower client demand and inventory destocking are not doing WestRock any favors. The macroeconomic outlook is not the greatest; however, the company is well-positioned to achieve structural long-term growth thanks to the Plastic to Paper thesis. ESG fund picking selection as well as e-commerce growth are still positive catalysts. Regarding WestRock's valuation, taking into account the higher debt at $9.5 billion, and rolling forward our EBITDA line now at $3 billion, we are lowering our target price from $70 per share to $55 per share. As always, we derive the company's valuation using the average of the two following methodologies:

1. A 7.0x EV/EBITDA on our 12-month forward estimates (a lower multiple than International Paper);
2. A DCF valuation with the same estimates on IP on a 10% cost of equity and a terminal growth rate of 2%.

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