Is WRK’s drop a warning sign – or an opportunity?

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. A lot of those concepts can be summarized into cute little sound bites that make them easier to remember and work with. One of the first ones I learned more than two decades ago has become a primary reference point for helping me think about the likelihood a stock will move the way I want: “the trend is your friend.”

For bullish traders, this saying means that if you can find a stock that is already going up, it is likely to keep going up – especially if the stock has broken above previous highs. It can also be applied to stocks in downward trend for the same kinds of traders, because downward trends generally act as warning flags for momentum-based, trend-driven investors to stay away, at least for the time being.

All of the logic I just outlined gets turned on its head a bit when you start talking about principles that drive other, longer-term investing methods and approaches. The longer my investing career has lasted, the more I’ve gravitated to value-driven strategies. Being a value investor doesn’t automatically dismiss the idea of using trends, but it is a bit counter-intuitive to some at first, because it doesn’t shy away from stocks in downward trends. 

I’ve learned that those same downward trends often provide the basis for many of the best value-based investments I’ve made. That’s because the downward trend tends to push the stock’s price further below the “fair” value the market generally tends to give it. If the company’s core fundamental strength is still in place, the downward trend can simply be attributed to current market action, which also implies the market will eventually recognize the stock’s deeply discounted status as well. Value-driven analysis provides investors like me an opportunity to identify where those opportunities may lie before the rest of the market starts to jump onboard.

Westrock Company (WRK) is a stock that has followed a downward trend since hitting a 52-week high in May, and that has seen than trend accelerate sharply in the last week as broad market uncertainty has also increased. I attribute most of that trend to cost increases that practically every sector has been dealing with for most of this year, and that have bled into customer prices. Despite those pressures, and more recent fears about a new, emerging coronavirus variant, WRK is a company that has weathered the storm of the past couple of years better than most; they have managed to retire a significant amount of long-term debt while also demonstrating healthy free cash flow and improving, more disciplined operating controls. What about its value proposition? The stock is currently more than -30% off of its 52-week high, and has dropped about -10% in just the last week. The downward trend is certainly interesting to a contrarian, value-oriented investor, but is it enough to also provide the basis for a good long-term, value-driven opportunity? Let’s dig in.

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 $12 billion.

Earnings and Sales Growth: Over the past year, earnings increased 68.5%, while sales rose 13.84%. In the last quarter, earnings were 23% higher, while sales grew by about 5.7%. In 2020, WRK’s operating profile dipped into negative territory, but has improved this year. Over the last twelve months, Net Income was 4.47% of Revenues, and strengthened to 6.36% in the last quarter. This pattern is a good confirmation of the positive earnings pattern just described.

Free Cash Flow: WRK’s Free Cash Flow is healthy, at $1.47 billion, and which translates to an attractive Free Cash Flow Yield of 12.25%. It does mark a decline over the last year, when Free Cash Flow was $1.6 billion, is still well above mid-2020 levels, when this number was around $1.1 billion.

Debt to Equity: WRK has a debt/equity ratio of .69, which is pretty conservative. The company’s balance sheet shows limited liquidity, with cash and liquid assets of about $290.9 million in the last quarter versus long-term debt of about $6 billion; however it should be noted that just a few months ago, long-term debt was a little over $8 billion. Most of their long-term debt came from the 2018 acquisition of KapStone Packaging, of which they have retired more than $2.7 billion, which strongly indicates the company should have no problem servicing the debt they have.

Dividend: WRK pays an annual dividend of $1.00 per share, which at its current price translates to a dividend yield of about 2.22%. After cutting their dividend by 57% in 2020 to preserve cash during the early stages of the pandemic, management increased the dividend by 20% in May of this year and again from $.96 after the latest earnings announcement. These are moves that signal management’s increasing confidence in the underlying strength of their business.

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 a little above $54 per share. That suggests that WRK is undervalued by about 20% from its current price, and a very useful bargain price at around $46.50. This is a number that declined from August of this year, when this same analysis yielded a fair value target of $58 per share.

Technical Profile

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

Current Price Action/Trends and Pivots: The chart above displays the last year of price activity for WRK. The diagonal red line marks the stock’s upward trend from February of this year to mid-May, with the peak at around $62. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. From that peak the stock slid steadily back into a short-term downward trend that finally found significant support at around $49 and settled into a trading range until October, and accelerated even more at the of last week. The stock appears to have found new support this week at around $43.50, a little above $88.6% retracement line, with immediate resistance sitting at around $47 based on pivot lows in that price area in October. A push above $47 should have near-term upside to about $50, with additional room to about $52 if bullish momentum persists. A drop below $43.50 could fall all the way to the stock’s 52-week low at around $40 before finding next support.

Near-term Keys: WRK’s downward trend is pretty scary to look at if you focus strictly on short-term, growth-oriented strategies; but the company’s underlying, fundamental strength, along with the downward trend have really just served so far to make the stock’s value proposition more attractive. Considering the current state of uncertainty in broad market conditions, you should consider whether you’re willing to accept the potential for increased volatility in WRK before taking on a new, long-term investment, or if it might be wiser to wait for signs that those conditions are starting to settle before looking for an entry point. If you prefer to focus on short-term trading strategies, a push above $47 could be a signal to think about buying the stock or working with call options, with a quick profit target at around $50. A drop below $43.50 could be a useful signal to consider shorting the stock or buying put options, with the stock’s 52-week low at around $40 providing a practical exit target for a bearish trade.