WestRock's Strategic Overhaul Should Unlock Value Despite Near-Term Packaging Headwinds 

Equity Analyst

Spencer Liberman

WestRock manufactures corrugated packaging and consumer packaging products, such as folding cartons and paperboard. It accounts for roughly 20% of the North American containerboard market and is the second-largest producer. WestRock was formed from the 2015 merger of RockTenn and MeadWestvaco, which combined two of the largest containerboard and paper companies in North America. WestRock’s formation is a result of a decade of consolidation in the containerboard industry, where four players now account for over 70% of the previously fragmented market. During this time of consolidation, producers were able to raise prices and expand margins, but increased competitive intensity and rising input costs have weighed on profitability in recent years.

WestRock’s main operations involve manufacturing containerboard and paperboard to produce corrugated packaging products. While the majority of the company's containerboard and paperboard is used internally, a portion is sold on the open market to local or regional box manufacturers through its global paper segment. The firm's corrugated packaging products are used in a variety of end markets, including food and beverage, e-commerce, paper products, and other goods. Corrugated boxes provide a strong yet lightweight packaging option that is cost-effective. This dynamic has made corrugated boxes a favorite in the packaging industry and is used in many different end markets. While a majority of its packaging sales are in North America, WestRock has increased its exposure in South America in recent years.

Business Strategy & Outlook

We do not think WestRock benefits from an economic moat, despite being the second-largest containerboard manufacturer in North America. The majority of WestRock’s business (95% of fiscal 2023 revenue) involves manufacturing containerboard, which is mainly used in corrugated packaging products. Over the last two decades, consolidation has shifted a once fragmented industry into four major players and a handful of smaller firms due to the high capital costs required to efficiently produce containerboard. Almost 90% of WestRock’s sales are in North America, where the firm produces approximately 20% of the containerboard supply. While there are some traces of efficient scale and cost advantage moat sources, we do not think they are substantial enough to award WestRock an economic moat.

WestRock is one of the largest producers of containerboard and corrugated packaging in North America. The containerboard industry has gone through a period of consolidation, with four players now controlling roughly 70% of the supply. Many incumbents have deep roots in traditional paper but have since pivoted to containerboard as demand for paper declined and the demand for corrugated packaging rose. Machines used to make paper can be converted to produce containerboard, making it an attractive opportunity for legacy paper producers looking to capitalize on growing containerboard demand while divesting from the slowing freesheet paper business. This offered legacy paper producers a low-cost avenue to increase containerboard capacity. Additionally, e-commerce growth has increased regional and global shipping, with many opting to ship with corrugated packaging for its low cost and durability. This dynamic provided a strong incentive for paper companies to convert their aging paper mills to containerboard mills. Unlike other large competitors (that is, International Paper and Packaging Corporation of America), WestRock does not operate a traditional paper business. The company produces kraft paper and other types of packing paper but does not produce freesheet paper products. While other competitors converted paper assets to meet rising containerboard demand, WestRock did not have inefficient paper assets to convert. This increased the cost of containerboard capacity expansion for WestRock and hindered the firm’s ability to consistently outearn its cost of capital. Today, the corrugated packaging industry shows elements of a rational oligopoly but continues to face pressure from converted paper mills and threats of substitutes from plastic packaging.

We continue to see little contribution from the efficient scale phenomenon toward WestRock’s economic moat. The consolidated nature of the North American containerboard market, where four companies account for about 70% of supply, combined with the commoditized nature of containerboard make for an industry that could enjoy an efficient scale moat source. That said, the conversion of paper assets has increased capacity and limited containerboard price growth. Lower price growth has constrained margins and hindered WestRock’s ability to earn strong returns on its invested capital. While high capital costs usually inhibit new entrants from entering a market with efficient scale, smaller paper producers can join the market with relative ease by converting their paper assets to containerboard production.

As one of the largest containerboard producers in North America, WestRock could benefit from a cost advantage moat source, but we see little evidence that would suggest the company enjoys this competitive advantage. WestRock operates 28 containerboard and paperboard mills that are located across North America, Brazil, and India. Once the raw materials are processed at its mills, they are transported to one of its over 200 converting and packaging plants. Most of its plants are dispersed throughout North America to minimize the distance between the plants and customers due to the low value/weight ratio of corrugated board. WestRock’s competitors have comparable mill and plant footprints as they source raw materials in similar areas and require a dense plant network to service customers efficiently. While WestRock is the second-largest producer of containerboard and could benefit from scale, its production is spread across a handful of mills and numerous plants that each have their own fixed cost structures, preventing it from capitalizing on any operating leverage advantage.

For commodity producers, their position on the cost curve is significant. Operating as a low-cost producer can lead to years of strong economic profits and provide a durable competitive advantage. That said, the low value/weight ratio of containerboard forces producers to operate with a regional and even local presence, with each location having its own cost curve and rendering the industrywide cost curve largely irrelevant. WestRock’s substantial size within the containerboard industry does little to lower its operating and input costs, forcing the company to compete on price. Without a cost advantage or presence of the efficient scale phenomenon, we do not think that WestRock, being a commodity producer, possesses an economic moat.

None

Economic Moat

WestRock

WestRock was formed in July 2015 after the merger of MeadWestvaco and RockTenn. MeadWestvaco stockholders received 0.78 shares of the combined company. Rock-Tenn stockholders chose either one share of the combined company or a specific cash amount for each of their shares.

Kapstone  is an American pulp and paper company based in Northbrook, Illinois. The company has kraft paper manufacturing facilities in Roanoke Rapids, NC, Cowpens, SC, North Charleston, SC and Longview, WA, a lumber mill in Summerville, SC, 21 corrugated box and corrugated fiberboard plants and 65 packaging distribution centers. It has approximately 6,200 employees.

Kapstone

WestRock Co. engages in the provision of fiber-based paper and packaging solutions. It operates through the following segments: Corrugated Packaging, Consumer Packaging, Global Paper, and Distribution. The Corrugated Packaging segment consists of the sale of containers and other products including displays. The Consumer Packaging segment involves the packaging products such as folding cartons, interior partitions, inserts, and labels. The Global Paper segment focuses on commercial paper operations and generates its revenues primarily from the sale of containerboard, paperboard, and specialty grades to external customers. The Distribution segment distributes packaging materials and other specialty packaging products, including stretch film, void fill, carton sealing tape, and other specialty tapes. The company was founded on March 6, 2015 and is headquartered in Atlanta, GA.

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