Smurfit Westrock

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Smurfit WestRock (SWR), a global leader in paper-based packaging solutions, serves diverse industries with a focus on sustainable and customized packaging.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Smurfit WestRock (SWR) is a global leader in paper-based packaging solutions, offering a diverse range of products that span from containerboard and corrugated packaging to specialty printing and folding cartons. They serve various industries, including food, beverage, retail, agriculture, industrial, and healthcare. The company operates in several geographies across Europe, North and Latin America, and Asia, enabling it to cater to both regional and global customers. The company’s commitment to sustainability is underscored by its focus on recyclable materials and innovative solutions that support a circular economy.

Revenue Distribution

  • Europe: A major source of revenue, indicating a strong foothold in European markets.
  • North America: Significant revenue generation is also seen in the North American region.
  • Latin America: A growing segment, providing evidence of expanding reach.
  • Asia: A smaller but growing segment of the company’s geographical revenue.

Industry Trends

  • Sustainability Focus: There’s a growing global demand for eco-friendly packaging materials, pushing companies to move away from plastics and adopt more sustainable paper-based alternatives.
  • E-Commerce Boom: The rise in online retail is driving demand for more corrugated packaging solutions to handle and protect goods being shipped to consumers.
  • Customer Preferences: As tastes converge, technology improves, costs decline, and brewers learn how to leverage their expertise and brand names better, the industry has slowly begun to reach consumers on a global scale.
  • Consolidation in industries: The consolidation in industries in their client base increases the bargaining power of the client, especially large companies that tend to consolidate their purchases and drive down prices.

Competitive Landscape

  • The industry is highly fragmented and is influenced by the local supply and demand, resulting in variable prices.
  • SWR has several competitors in each of its operating markets: Mondi, Smurfit Kappa, International Paper, WestRock, and a number of smaller regional players. These firms are mostly trying to compete on price, so having a cost leadership strategy is crucial.
  • Competition is especially tough among low-cost commodity producers, so having an innovative process or differentiated product that could command a price premium is important.

What Makes SWR Different

  • Global Scale: The company operates across multiple continents, giving it a unique and global reach.
  • Vertical Integration: SWR owns more than 250 manufacturing and other facilities across the globe, which means it can control every step of the supply chain, from wood to final product, creating a massive cost advantage, compared to more niche competitors.
  • Sustainability Focus: SWR has taken a leadership position in environmentally friendly packaging solutions, which many clients are increasingly looking for.
  • Focus on Innovation: SWR is working to improve efficiency, productivity, and sustainability throughout their production processes and their products.

Financial Analysis

  • Revenue Growth: The company has reported that its revenues have increased from 2020 through 2023. However, these increases seem to be mostly tied to acquisitions rather than organic growth, which could be a concern for some investors. This means that SWR may be overpaying in acquisitions or simply adding to the company’s infrastructure, which might create a disadvantage rather than an advantage. The company’s revenue in 2021 was $14,785.1 million and was $14,489.9 million in 2022.
  • Profitability: Profitability has been inconsistent and below historical averages. EBITDA margin was as high as 14.2% in 2018, and has been slowly falling ever since, settling at around 11% in 2022. With such relatively high capital expenditure and debt costs, the company’s profits and free cash flows may be significantly underperforming. The company posted a net loss of $1,227.3 million in 2022.
  • Free Cash Flow: Free cash flow from operations has also declined from a high point in 2019, where it was $1,388.3 million, to $43.8 million in 2022. Negative free cash flow could lead to solvency issues in the future, even if the company has positive net income. There was an improvement in 2023, to $698 million, but that is still below historical norms and could signal problems in the current economic environment.
  • Acquisitions: The main driver of SWR’s growth has been acquisition, and their financial statements show it. This shows that the company’s growth is not as organic as one would expect. From a value point of view, this is particularly bad, since acquisitions may not give any advantage if they come at a premium, since the value created goes to the seller.
  • Net Debt: Net debt has been growing, and was almost at $7.9 billion in 2022. This has resulted in a very high debt-to-capital ratio that could create solvency concerns in the future. At the start of 2023, debt was 56% of the company’s capital.
  • Intangible Investments: Intangible investments, including goodwill and purchased R&D, have also shown a similar trend of growth, from $1.9 billion in 2020 to over $3.7 billion in 2022. High intangible assets are mostly due to the company’s intense acquisition strategy, and should be looked at carefully, since they may be overvalued, or not produce any future economic returns.
  • Capital Expenditures: Capital expenditure has been falling since 2018, which may show a problem in investing in the company’s operations. This is also confirmed by the company’s CEO saying in an earnings call that they are looking to reduce capital expenditure over time.
  • Management’s guidance: The management has shown a willingness to reduce debt levels over time, while maintaining current growth levels. They have also communicated that they are looking to move into other areas of the packaging business such as recycled materials, to grow revenues.
  • Ownership: While institutional investors have increased their holdings, they still only own around 30% of the company’s equity. This may be of concern for investors, since larger companies are generally owned at least 60% by institutions.
  • Overall: As it stands now, SWR is a company that had a disappointing 2022, which showed both lower revenue and a net loss, while the debt also grew to a considerable amount.

Moat Analysis

Based on the information available, here’s an assessment of SWR’s economic moat:

  • Intangible Assets (Brands and Patents): SWR holds multiple recognizable brands. However, these brands may not offer significant pricing power relative to competitors. Also, their patents are limited to specific technologies. This may give a minimal barrier to entry but doesn’t create a wide competitive moat for SWR.
  • Switching Costs: There are no significant switching costs for the customers, which means they can easily switch to their competitors’ products without much hassle.
  • Network Effects: There are no noticeable network effects. The company can’t benefit from network effects, and will rely on improving product quality, reducing costs, and increasing willingness to pay from customers, which may not be an effective strategy for the long term.
  • Cost Advantages: Cost advantages may be the biggest aspect of SWR’s moat, stemming mostly from economies of scale and ownership of raw material sources. They operate over 250 facilities, with a wide reach across many countries, and they have some ownership of their sources for raw materials. However, they still buy a large percentage of their inputs, and as we have seen, they are subject to fluctuations in industry structure, price, and technology. Their cost advantage is not particularly strong, as the company’s operating costs have been growing at higher rates than their revenues. There are signs that their market share, and therefore their competitive position, is declining.
  • Conclusion: Based on the analysis, SWR has a moderate moat that is mostly driven by its size and its cost advantage compared to more local players. However, these advantages are fragile and have shown a history of erosion. Therefore, SWR is given a 3 / 5 on its moat.

Risks to the Moat

  • Industry Cyclicality: The paper and packaging industry is highly cyclical and vulnerable to changes in demand and material prices, meaning SWR’s profitability can fluctuate. If the demand plummets, or if prices spike too high, the company may be forced to incur losses, which may cause irreversible damage to the company.
  • Commodity Pricing: SWR is a commodity business that produces generic products, meaning that it is vulnerable to fluctuations in commodities prices. The fluctuation in wood, energy, and other raw material costs affect its profitability.
  • Technological Disruption: The fast paced evolution of technology can create newer, different, and cheaper forms of packaging, such as plastic or composites, which could threaten SWR’s position in the market.
  • Economic Downturn: An economic downturn could reduce demand from various clients who consume SWR’s products, resulting in depressed prices and a lower valuation of the firm’s assets and shares.
  • Acquisition Risk: The acquisition strategy of the company may backfire if integrations are unsuccessful or if the acquired entities have a different culture and operational process. Synergies may also not be realized, or the acquired companies may be overvalued, resulting in losses for SWR.

Business Resilience

  • Diversification: SWR does business in multiple countries, and across different industries. This means they are not dependent on any single customer, country, or industry, which gives the business a level of resilience.
  • Focus on Sustainability: SWR’s focus on sustainability has created opportunities for higher demand and for attracting new customers, allowing it to grow at a faster pace.
  • Ownership of Raw Material Sources: SWR has some control of its raw material sources, which gives a layer of resilience against the volatility of prices.
  • Overall: SWR is moderately resilient, having several avenues to prevent a collapse. However, its high level of debt and the low switching costs in its customer base are a major downside.

Understandability Rating: 3 / 5

SWR’s business model is reasonably straightforward to grasp, focusing on the production and distribution of paper-based packaging materials. However, the details of its financial statements are not so easy to understand. Their acquisitions and their method of incorporating these new entities in their financials creates considerable complexity, and thus SWR’s understandability is not a 1 or 2 out of 5.

Balance Sheet Health: 4 / 5

SWR has a decent balance sheet, with a high proportion of long-term debt. Their current assets are able to cover current liabilities more than 2 times over, which shows that they do not face an immediate solvency crisis. The company also has a high level of goodwill and intangible assets, which may cause problems if the value of those assets are impaired. Given the current state of the company, an analysis of future financial health requires careful scrutiny and management, particularly focusing on the ability of the company to maintain current revenues and to reduce expenses.