WRK is testing its yearly lows – does that mean its value proposition is getting better?

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 even as the market tends to overprice good news (and positive expectations) into stocks, it also often over-punishes bad news or less-than-rosy expectations. In the negative case, that means downward trends often push stock prices further below the “fair” values the market generally tends to give them. 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.

The caveat, of course, lies in the fundamental data. If the company’s fundamentals are showing deterioration, over time or across multiple metrics, there is a stronger case to make for another common idiom technicians love to quote: “the market is always right.” That’s why using value investing concepts to drive investment decisions can sometimes be challenging.

Westrock Company (WRK) is a stock that has followed a downward trend since hitting a 52-week high in May of last year, but saw the trend bottom in December and has mostly been moving sideways since then, with a consolidation range between about $47.50 and $43.50. The market’s broadly bearish momentum lately has pushed the stock near to the bottom of that range and within sight of its 52-week low price at around $42 per share. I attribute the beginning of the trend to cost increases that practically every sector has been dealing with the past year, and that have bled into customer prices. Despite those pressures, WRK is a company that has weathered the storm of the past couple of years better than most; but the latest round of earnings data illustrates some patterns that could signal larger problems are ahead. This is a stock that in 2021 offered a very useful value proposition, but the question now is how the concerns I just mentioned have impacted that argument. Is it still as an attractive an opportunity as it has been? 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 6.56%, while sales rose 12.51%. In the last quarter, earnings were -47% lower, while sales slipped by about -2.72%. Over the last twelve months, Net Income was 4.5% of Revenues, but weakened to 3.68% in the last quarter. Along with the quarterly decline in earnings and revenues, this is the first red flag that I think bears watching. 

Free Cash Flow: WRK’s Free Cash Flow is healthy, at $1.02 billion, and which translates to a Free Cash Flow Yield of 8.95%. It does mark a decline over the last year, when Free Cash Flow was $1.6 billion, and $1.7 billion three quarters ago. The sustained pattern of declining Free Cash Flow is my second red flag.

Debt to Equity: WRK has a debt/equity ratio of .68, which is pretty conservative. The company’s balance sheet shows limited liquidity, with cash and liquid assets of about $291.3 million in the last quarter versus long-term debt of about $8 billion. The company focused for most of 2020 and 2021 on debt reduction, most of which came from the 2018 acquisition of KapStone Packaging. As of the latest report, they have retired enough of that debt to reinstate stock buybacks, but even so, long-term debt increased from around $6 billion in the last quarter.

Dividend: WRK pays an annual dividend of $1.00 per share, which at its current price translates to a dividend yield of about 2.3%. 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 two quarters ago. 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 $48 per share. That suggests that WRK is undervalued by about 11% from its current price, with a useful bargain price at around $39. This is a number that declined from August of 2021, when this same analysis yielded a fair value target of $58 per share, and $54 prior to the latest earnings announcement.

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 downward trend from May of 2021, when the stock peaked at around $62, to its December low at around $42. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. Since bottoming in December, the stock has staged a couple of temporary rallies to around $47, where I am marking immediate resistance, before falling back again to current support at around $43. The stock has been picking up bearish momentum along with the rest of the market and is nearing support right now. A drop below support will find next support very close, at around $42 where the stock’s 52-week low sits, but additional bearish pressure could force the stock lower, to between $38 and $39. A push above $47 should find next resistance at around the 38.2% retracement line, which is sitting right around $50 per share.

Near-term Keys: WRK’s downward trend has held throughout the start of the year, and with the broadly bearish momentum that exists in the market right now, it’s hard to suggest the stock has a lot of reason to go higher. The company is also waving enough red flags right now that I would be hesitant to think about WRK as a new, long-term, value-focused strategy. The fundamental problems I’ve outlined could be cyclical in nature, and given management’s excellent track record, that is a reasonable argument to make. Even so, I think the smart thing is to wait and see if the stock’s consolidation range holds, breaks down, or reverses upward, and to keep a close watch on the next couple of quarters of financial results. If you prefer to focus on short-term strategies, a bounce off of $43 could offer a signal to think about buying the stock or working with call options, with a quick profit target at the top of the stock’s current consolidation range at $47, and $50 possible if bullish momentum increases. A drop below $42 could be a useful signal to consider shorting the stock or buying put options, with $39 to $38  providing practical exit target for a bearish trade.