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Favorable Demand to Drive WestRock Despite Higher Input Costs

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On Aug 6, we issued an updated research report on WestRock Company (WRK - Free Report) . Favorable demand, price and mix trends across paper and packaging businesses will drive the company’s fiscal 2018 results. Execution of its capital allocation strategy and the acquisition of KapStone Paper and Packaging Corporation , once complete, will also aid growth. However, increased debts to fund the deal along with inflationary costs of raw materials remain headwinds.
Higher Earnings & Revenues in Q3
WestRock recently reported third-quarter fiscal 2018 adjusted earnings of $1.09 per share, a year-over-year improvement of 47%. Total revenues rose 12% year over year to $4,138 million. The year-over-year improvement in sales was primarily driven by increased sales in the Corrugated Packaging. This can be attributed to improved selling price as well as higher Consumer Packaging segment, which in turn was aided by the Multi Packaging Solutions International Limited (“MPS”) acquisition.
Sound Fiscal 2018 Anticipated Despite Inflated Costs
The company anticipates fourth-quarter fiscal 2018 adjusted earnings per share to improve significantly from third-quarter’s adjusted EPS of $1.09. Maintenance downtime is expected to decrease by 133,000 tons sequentially across its mill system. Lower maintenance downtime and other items will have an estimated $38 million cost benefit quarter over quarter. These factors, along with sales price increases, seasonally higher volumes, favorable mix and continued productivity gains will lead to sequential rise of $68 million to $83 million in adjusted EBITDA.
Transportation costs have been high lately and are expected to persist in the near term. Overall, input costs are projected to be in the range of $10 million to $15 million higher than the third quarter. Adjusted EPS in fourth-quarter fiscal 2018 will also be unfavorably impacted by a higher expected tax rate, higher depreciation and amortization.
The Zacks Consensus Estimate for the fourth quarter fiscal 2018 is pegged at $1.26, reflecting year-over-year growth of 45%.
WestRock is benefiting from favorable demand, price and mix trends across its paper and packaging businesses. The company projects generating revenues of around $16.3 billion and adjusted segment EBITDA to come in above $2.9 billion in fiscal 2018. Adjusted EBITDA margins are likely to increase by more than 250 basis points year over year to approximately 18%.
The Zacks Consensus Estimate for fiscal 2018 is $4.07 (55% year-over-year growth) on the back of revenues of $16.3 billion (10% year-over-year growth).
Productivity Improvements to Aid Results
WestRock was formed by the merger of MeadWestvaco and Rock-Tenn in July 2015. The company is realizing the strategic benefits of the merger. In third-quarter fiscal 2018, the company achieved its $1 billion target for synergy and performance improvements. This was achieved by the productivity and performance improvement programs across its manufacturing footprint, as well as cost savings from capital investments. Further, manufacturing optimization and reductions from the elimination of duplicate corporate costs and support functions will support results.
KapStone Buyout to Enhance Presence & Product Portfolio
WestRock previously announced that it will acquire all the outstanding shares of rival KapStone at $35 per share and the assumption of approximately $1.36 billion in net debt, for a total enterprise value of approximately $4.9 billion. The buyout is expected to conclude by the end of the 2018, subject to customary closing conditions. On conclusion, it is anticipated to be accretive immediately to the company’s adjusted earnings as well as cash flow. It is projected to lead to around $200 million of annual cost synergies and performance improvements, with half to be realized within first 12 months.
KapStone’s corrugated packaging operations will enhance WestRock’s North American corrugated packaging business. It will help strengthen presence in western United States and to compete better in the growing agricultural markets in the region. The company will also be able to broaden portfolio of paper grades, allowing it to capitalize on the kraft bag market with the inclusion of KapStone's complementary specialty kraft paper offerings.
Higher Debt to Fund Deal 
WestRock plans to fund the cash portion of the KapStone deal through new debt and plans to refinance KapStone's assumed debts at the close of the deal. The company’s current debt-to-capitalization ratio is at 36%. Higher interest expenses will affect margins.
WestRock has underperformed the industry with respect to price performance over the past three months. The stock has dipped 6.3%, while the industry has recorded growth of 1.3%.
Zacks Rank & Stocks to Consider
WestRock currently has a Zacks Rank #3 (Hold) and an impressive VGM Score of A. Here V stands for Value, G for Growth and M for Momentum. The score is a weighted combination of these three scores (Value - B, Growth - A, Momentum - B). Such a score allows you to eliminate the negative aspects of stocks and select winners. The VGM Score of A, along with some other key metrics, makes the company a solid choice for investors.
Some better-ranked stocks in the sector include Domtar Corporation (UFS - Free Report) and International Paper Company (IP - Free Report) . Both the stocks sport a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Domtar has expected long-term growth rate of 5%. Its shares have gained 11% over the past three months.
International Paper has expected long-term growth rate of 28.5%. Its shares have appreciated 2% over the past three months.
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