WRK’s stock price is struggling to recover – that might be a good thing

While COVID-19 isn’t going to go away anytime soon, the continued reopening of the economy and the constant change that are current events are starting to shift conversations into various other topics. A lot of focus now is being put on protests and demonstrations not only across the U.S. but even around the globe. What kind of impact those will have on the financial markets is probably muted for the most part as investors prefer to focus on questions that will have the most direct effect on business operations and, so on stock prices.

Even so, economic questions remain. Not only is unemployment still high, but just how long it will take for jobless claims to begin dropping to more normalized levels is a questoin that I think is going to take months, not weeks to truly answer. Despite the market’s clear bias towards a quick, V-shaped recovery, the truth is that at best the economy’s recovery will take a more gradual, U-shape, and could very well take a long-term L-shape. An underreported element of risk also comes from the trade front, where U.S.-China tensions have been increasing of late and could threaten to undo progress that had been made prior to the pandemic.

While the broad market has rebounded quickly, and in the case of S&P 500 Index, is now only about 10% off of its pre-pandemic and bear market highs, a lot of stocks in the mid-cap and small-cap segments of the market have struggled to follow suit. These are companies that don’t necessarily the breadth and scope of their larger industry brethren, and who in many cases don’t possess the financial resources that may be required to weather an extended, long-term storm. That’s part of the reason that I most of the market’s rebound since March has been localized primarily in the largest and most well-known names in corporate America.

That doesn’t mean that all smaller companies are at the same disadvantage; in fact, the relative underperformance of the stock prices of many of these companies may actually spell an interesting opportunity for a patient, and cautious value-oriented investor under the right conditions. While many smaller companies are restricted by the financial resources they have access to, there are others who may be restricted in size only by the end markets they provide goods and services to. When you drill down and look at their fundamentals, you can sometimes find the same kind of solid fundamental characteristics that some of their larger competitors would be envious of. 

Westrock Company (WRK) is a good example of the kind of stock I’m referring to. This is a company that occupies an interesting niche in the Materials sector, providing paper and packaging solutions for consumer and corrugated packaging markets. That doesn’t sound very glamorous – but it means that the cardboard boxes, paperboard, and merchandising display materials you see on products you use every day, or in the grocery and department store are, in many cases coming from this company. Despite a generally solid fundamental profile, the stock price has suffered over the last couple of years before it finally began to rebound in late 2019. COVID-19 and the economic pressures that have come from it have certainly played their role in the stock’s price performance, driving the stock to visit lows in the mid-to-low $20 range on two occasions since March. And while their bottom line has been impacted by the economic slowdown caused by COVID-19, their most recent earnings report suggests that they’re holding up remarkably well. I think that could mean that the stock’s value proposition, which was already attractive before the pandemic, is still only even more compelling.

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 $7.5 billion.

Earnings and Sales Growth: Over the past year, earnings declined -16.25%, while sales were -3.74% lower. In the last quarter, earnings improved by 15.5%, while sales were flat, but positive at 0.53%. 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 4.67% of Revenues, and narrowed to about 3.33% in the last quarter.

Free Cash Flow: WRK’s Free Cash Flow is healthy, at $919.2 million, and which translates to an attractive Free Cash Flow Yield of 13.3%. This free cash flow number is only slightly lower than the quarter prior, when it was about $1.03 billion.

Debt to Equity: WRK has a debt/equity ratio of .91, which is generally conservative but has increased since November 2018 from just .49. The company doesn’t have great liquidity, with cash and liquid assets of about $640 billion versus $10.4 billion in long-term debt; however is is interesting to note that in the quarter prior, cash was only a little over $151.6 million. It should also be noted that the increase in debt is primarily tied to the November 2018 acquisition of KapStone Paper & Packaging. WRK’s operating profile suggests that servicing their debt should not be a problem.

Dividend: WRK pays an annual dividend of $.80 per share, which at its current price translates to a dividend yield of about 2.8%. Management cut the dividend in the last quarter from about $1.80 per share annually to help preserve cash; however I think it is worth noting the company did not eliminate its dividend, which many other stocks have done in the last month or so in response to pandemic-related pressures.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $41 per share. That means that the stock is compellingly undervalued, with about 45% upside from its current price.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The diagonal red line marks the stock’s downward trend from January to March; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The rallied strongly from its bottom at around $21.50 to touch the 50% retracement line in late April; from that point, the stock plunged rapidly back a low at around $23 in mid-May before rebounding again to reach its current level around $28.50. Over the last week, the stock has started to turn range bound, with immediate resistance around $29 and support around $28. The 38.2% retracement line is also only about $1 above that resistance level, which means in practical terms that the stock would need to break above $30.50 to confirm any new bullish momentum. In that case, it should see upside to about $34, where the April peak lies, with additional room to run to around $35.50 if bullish momentum remains strong. A drop below $28, on the other hand, could see the stock drop to its next support around $25, with the next likely support level back around its multi-year lows in the $21.50 range.

Near-term Keys: While WRK has a solid fundamental profile and a compelling value proposition, the truth is that making a long-term investment in this stock right now means being willing to accept the very real likelihood that while WRK is currently showing some nice bullish momentum, the stock could also drop back near to its low point around $21.50. That requires a long-term perspective, betting on the company’s long-term growth prospects looking beyond 2020 and into 2021. If you prefer to work with short-term trading strategies, you could use a push above $30.50 as a signal to buy the stock or work with call options, using $34 to $35.50 as a useful exit target on a bullish trade. If the stock drops below $28, consider shorting the stock or working with put options, using $25 as a useful first-hit profit target and the stock’s low around $21 within range if bearish momentum persists.