SMFTF - WestRock: Solid Asset-Based But (Likely) Not The Right Time

2023-09-12 05:05:44 ET

Summary

• WestRock reported better-than-expected Q3 results, beating consensus estimates on EPS and EBITDA.
• WestRock's cost saving initiatives are exceeding the company's internal expectations.
• No valuation details on the potential merger combination.
• The company's earnings are under pressure, and valuation is at the bottom. Given WestRock assets, ongoing restructuring, and geographical footprint, we reiterated our buy rating target.

Here at the Lab, in conjunction with our Smurfit Kappa Potential Merger release ([[SMFKY]], [[SMFTF]]), we are back to comment on WestRock (WRK). Since last week, the two companies are currently " engaged in a mutual due diligence process. Any transaction's definitive terms and conditions will be set out in a further announcement. Any Potential Combination would be conditional, among other things, upon the approval by shareholders of Smurfit Kappa and WestRock and receipt of required regulatory clearances and other customary conditions. " Before commenting on the potential combination, we would like to recap the company's Q3 results. We closely follow WestRock and this year, we already analyzed the company twice:

1. Q1: Disappointing Guidance ;
2. Q2: Accelerating On Its Transformation .

Q3 Results Recap

WestRock's adjusted EBITDA reached $802 million and was above Wall Street consensus that was forecasting $699 million. This beat was also higher than the company's internal estimates. WestRock was guiding an EBITDA between $650 and $750 million. Looking at the details, this positive result was achieved through cost-saving initiatives and an easing of raw material inflationary pressure with a few input costs in deflation. Going to the top-line sales, WestRock turnover declined by 7% on a yearly basis to $5.12 billion, and EBITDA margins contracted by 250 basis points to a margin of 15.7% (above consensus of 13.5%) (Fig 1). Despite price weakness in containerboard and corrugated markets, the company delivered a solid price mix evolution. More importantly, the company is ahead on cost savings initiatives and now aims to exceed $450 million in the Fiscal Year 2023. Q4 EBITDA guidance is estimated between $675 and $725 million and aligns with Wall Street expectations. The guidance assumes lower price, slightly higher energy cost, and lower cost in chemicals and virgin fiber with an EPS in the $0.66 - $0.83 range (Fig 2). Here at the Lab, we are positively optimistic about the containerboard segment, as we believe we moved away from March and April 2023 volume. However, the pricing level remains subdued, and we expect investors will pay more attention to H2 2023 earnings, looking for any indications of profitability improvement.

Source: WestRock Q3 results presentation - Fig 1

Fig 2

Smurfit Kappa Potential Merger Combination

Looking to the Smurfit Kappa's communication, including our comment, we report the following:

1. The potential deal could result in a share swap. Why? " Any such combination would result in Westrock shareholders receiving consideration consisting primarily of the Combined group's shares ." Therefore, if the deal goes on, Smurfit Kappa stocks would be de-listed from Euronext and would be traded in the NYSE;
2. Cross-checking the forecast P&L, the deal combination forecasts a total turnover of $34 billion with an EBITDA of $5.5 billion;
3. The companies are in the due diligence process; however, they already reported to have cost synergies of circa $400 million;
4. The business combination would create a global leader with two companies with GEO sales mainly related to the domestic market. WestRock sales are focused in North America (90%), while Smurfit Kappa turnover is more than 3/4 in the EU. Here at the Lab, there is not much geographical overlap aside from the South American region. This is the reason why we see limited synergies;
5. Currently, no financial terms have been reported yet;
6. This merger combination needs shareholders' approval and also the green light from the regulatory antitrust. On the latter, we believe this is not an issue, given their respective geographical footprint;
7. WestRock is trading at a discount within the sector. This was one of the reasons for Mare Ev. Lab buy rating target.

Conclusion and Valuation

WestRock fundamentals remain under pressure at a time when Smurfit Kappa is stepping in. On paper, this potential combination would benefit Smurfit with an expansion in North America following the recent acquisition in Brazil and Argentina . In addition, last year, WestRock completed the Grupo Gondi acquisition. Therefore, Mexico is another country where the combined entity would already be present. However, no financial details are available on the transaction. Valuations have not been reported, which is critical to assessing the WestRock shareholders' deal.

Following the Q3 results, here at the Lab, we are adjusting our valuation. We are moving from our $3 billion in EBITDA to $2.8 billion, given a weaker price environment, lower volumes, and an ongoing restructuring process . The company delivered $479 million in adj. FCF is using the cash surplus to pay down debt. For this reason, rolling forward our financial debt, we arrived at a total obligation of $8 billion. Continuing to value WestRock on a 7.0x multiple on the EV/EBITDA, we arrive at a valuation of $42 per share. However, Westrock valuation is much cheaper than Smurfit Kappa's. WestRock trades at 4.9x 2024 EV/EBITDA, while SGK trades at 5.85x. Given the limited deal disclosure, we positively view this announcement for WestRock. This is a solid indication of their assets base and also GEO MIX. Despite that, we are not pricing in any potential development. Therefore, we view this supportive M&A as a current upside and reiterated our buy rating estimates.

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