The longer you invest in the stock market, the more familiar you become with a lot of the concepts that are used to define and justify the various investing methods that drive them. Years ago, as I began to incorporate technical analysis and shorter-term trading strategies into my system, one of those basic principles was the idea that “the market is always right.” This is an idea that a lot of technicians also like to refer to as “efficient market theory.”
Efficient market theory holds that asset prices fully reflect all available information at any given point in time – in other words, that no matter what is driving a stock’s price right now, it is a perfect reflection of all of the information available about that stock. The strength of the theory that I found helpful in my own investing was the way it helped me begin to disconnect the natural desire we all have to believe a stock “should” move in one direction or another. Instead, it taught me to simply use a stock’s current information – technical or fundamental – to evaluate the direction and type of investment that I thought best fit those current conditions.
The idea that Mr. Market is always right is a bit at odds, in my opinion with other, longer-term investing strategies like value investing. That isn’t because a value-oriented investor is given license to operate on a less objective basis, but rather because a core principle behind value analysis isn’t just about what a stock’s price is right now, or what direction it could move in the near term, but also about what whether that price represents a bargain right now. The idea a stock could be cheap automatically infers an opinion about what a stock’s price should be versus where it is now, and that is where I think the disconnect between efficient market theory and value analysis is found.
Westrock Company (WRK) is an interesting case in point. The stock followed a long-term downward trend that began in January 2018 and saw the stock decline from a peak at around $71 to a recent low at around $32 in late August. From that point, the stock has rallied around 25% to its current level around $40, which is a big enough move to signal a major reversal of the longer-term downward trend and would make most technical, growth-oriented traders start to salivate. A value investor, on the other hand will look at that same trend, and should automatically wonder how much opportunity is left. The interesting thing is that there are some holes in this stock’s fundamental profile that suggest that for once, both Mr. Market and Mr. Value Investor might be able to agree with each other.
Fundamental and Value Profile
WestRock Company, incorporated on March 6, 2015, is a multinational provider of paper and packaging solutions for consumer and corrugated packaging markets. The Company also develops real estate in the Charleston, South Carolina region. The Company’s segments include Corrugated Packaging, Consumer Packaging, and Land and Development. The Corrugated Packaging segment consists of its containerboard mill and corrugated packaging operations, as well as its recycling operations. The Consumer Packaging segment consists of consumer mills, folding carton, beverage, merchandising displays, and partition operations. The Land and Development segment is engaged in the development and sale of real estate primarily in Charleston, South Carolina. WRK has a current market cap of $10.3 billion.
Earnings and Sales Growth: Over the past year, earnings declined -3.88%, while sales improved about 9.8%. In the last quarter, earnings improved by 11.7%, while sales were flat, but negative by -0.82%. WRK operates with a very narrow margin profile, which isn’t especially unusual for stocks in this industry; over the last twelve months, Net Income was 4.71% of Revenues, and improved to about 6.68% in the last quarter. This is a sign of strength that indicates the company is starting to see long-anticipated accretion to earnings from the November 2018, $4.8 billion acquisition of KapStone Paper & Packaging that was completed a year ago, and which used debt to finance a large portion of the acquisition. Management, and most analysts expect the acquisition to continue to be accretive to both earnings per share and cash flow, meaning that these numbers should all continue to see significant improvement in the months ahead.
Free Cash Flow: WRK’s Free Cash Flow is healthy, at $1.06 billion, and which translates to an attractive Free Cash Flow Yield of 10.3%.
Debt to Equity: WRK has a debt/equity ratio of .81, which is pretty conservative but has declined since November 2018 from just .49. The company doesn’t have great liquidity, with cash and liquid assets of a little over $179 million in the last quarter versus long-term debt of more than $9.5 billion; it is worth noting that the increase in debt, which also corresponds to a significant decline in cash over the last year, is primarily tied to the KapStone acquisition.
Dividend: WRK pays an annual dividend of $1.82 per share, which at its current price translates to a very attractive dividend yield of about 4.65%. The passive income the stock’s fat dividend offers could be a compelling factor to consider for holding the stock and letting the price work through whatever market conditions do to the stock in the long term.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for WRK is $45.46 per share. At the stock’s current price, that translates to a Price/Book Ratio of .88. The stock’s historical Price/Book ratio by comparison is 1.34 and puts the top end of the stock’s long-term price target at almost $61 per share. The stock’s Price/Cash Flow ratio provides an even more optimistic view, since the stock is currently trading more than 71% below its historical average. Together, both elements put the stock’s long-term target price between $61 to $68.55 per share – which remains pretty compelling, even with the stock’s increase since August. When you factor the KapStone acquisition, which should help to give the company an opportunity to expand its profitability significantly, along with generally positive progress in trade and expected, continued strength in the U.S. economy, the market should have plenty of reason to keep pushing the stock higher for the foreseeable future.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: WRK’s downward trend from late January 2018 to its bottom at the end of August is easy to see. That trend found a bottom at around $32, as the stock has rallied from that point and has begun to develop a solid, short-term upward trend that is about to extended to an intermediate period of time. Immediate resistance is around $41, based on a pivot high from just about a week ago. A break above that level should give the stock momentum to rally to around $45, based on pivot activity in November of 2018, with the 38.2% Fibonacci retracement line around $47 within sight if bullish momentum continues. Current support is around $39, and if the stock drops below that price, its next most likely support level is probably around $35, based on pivot points seen in July of this year.
Near-term Keys: Given the strength of the stock’s upward trend since August, if you want to work with short-term trading strategies, the best bet is to use a push above $41 as a signal to buy the stock or work with call options, with a near-term price target at around $45 per share. If, however, the stock’s momentum turns bearish, a drop below $39 could be a good indication to short the stock or think about using put options, with a target at around $35 for a bearish trade. What about the stock’s value proposition? The company’s improving Net Income and healthy Free Cash Flow offer a pretty solid case for the strength of the stock’s long-term opportunity, and the stock’s fat dividend provides a very attractive passive income source as well.