WestRock Co (WRK) 2019 Q1 法說會逐字稿

Good morning. My name is Shelley, and I will be your conference operator today. At this time, I would like to welcome everyone to the WestRock Company First Quarter Fiscal 2019 Results Call.

At this time, I would like to turn the call over to Mr. James Armstrong, Vice President of Investor Relations. Please go ahead, sir.

Thank you, operator. Good morning, and thank you for joining our first quarter 2019 earnings call. We issued our press release this morning and posted the accompanying slide presentation to the Investor Relations section of our website. They can be accessed at ir.westrock.com or via a link on the right side of the application you are using to view this webcast.

With me on today's call are WestRock's Chief Executive Officer, Steve Voorhees; our Chief Financial Officer, Ward Dickson; the President of Corrugated Packaging, Jeff Chalovich; as well as our President of Consumer Packaging, Bob Feeser. Following our prepared comments, we will open up the call for a question-and-answer session.

During the course of today's call, we will be making forward-looking statements involving our plans, expectations, estimates and beliefs related to future events. These statements may involve a number of risks and uncertainties that could cause actual results to differ materially from those we discussed during the call. We describe these risks and uncertainties in our filing with the SEC, including our 10-K for the fiscal year ended September 30, 2018.

Additionally, we will be referencing non-GAAP financial measures during the call. We have provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the appendix of the slide presentation. As mentioned previously, the slide presentation is available on our website.

With that said, I'll now turn it over to you, Steve.

Thank you, James. Good morning. Thanks for joining our call today.

WestRock had another solid quarter with adjusted segment EBITDA of $733 million and adjusted earnings per share of $0.83. The WestRock team effectively and efficiently implemented our integration plans for KapStone, while addressing the challenges due to the substantial impact of Hurricane Michael on our Panama City mill. We're performing well in a challenging environment. We're keeping a close eye on the capacity announcements in North America and the global containerboard markets. We have ample opportunities to advance our strategy, take the steps needed to continue to improve our business.

We're making great progress on the integration of KapStone, and we're beginning to capture the $200 million of KapStone synergy and performance improvement opportunities. KapStone was accretive by approximately $0.04 in adjusted earnings per share for the 2 months we owned it during the quarter.

Our net leverage ratio at the end of the quarter was 2.89x. We're focused on returning our balance sheet to our 2.25x to 2.5x targeted leverage ratio, and we bought back $44 million of stock during the quarter.

The WestRock team continues to successfully execute our differentiated strategy, and we're collaborating with our customers to help them win in the marketplace. We're well positioned to deliver outstanding value to our customers and our stockholders.

Before turning to our segment results, I'm going to point out two changes that we made to our financial disclosure during the quarter. First, we changed how we conduct our recycling operations to a procurement model. What this means is that no recycling sales are recorded, and that the margin from our recycling operations reduces the cost of goods sold. Second, we moved our merchandising displays business from the Consumer Packaging segment to the Corrugated Packaging segment. We did this in recognition of the increasing overlap of the manufacturing capabilities in our display plants and our box plants. We've shown the impact of these changes in the appendix of our presentation.

Our sales in the quarter were $4.3 billion. This is 14.5% higher than last year, and this excludes the impact of recycling sales during the prior year period.

Adjusted segment EBITDA increased by $67 million or 9.8%. This was despite the loss in production and sales, resulting from the severe damage that Hurricane Michael caused to our Panama City mill.

Adjusted earnings per share decreased by $0.04 to $0.83 per share due to higher depreciation and amortization and a higher interest cost that more than offset the increase in EBITDA.

Let's turn to costs in the quarter. Costs were a stronger headwind than we anticipated. Natural gas prices spiked to more than $4.50 per MMBtu. Wood prices, especially hardwood prices, have been elevated as the wood baskets we draw from remained excessively wet. Somewhat offsetting the impact of higher natural gas and wood fiber, the impact of Hurricane Michael on our Panama City mill was $14 million favorable to our guidance. This is a testament to the tenacity of our team.

The Corrugated Packaging segment sales for the first fiscal quarter were $2.7 billion. This was an increase of 24% over last year. The increase is due to the KapStone acquisition and improved price and mix.

Our North American corrugated adjusted EBITDA margins were 21% as the KapStone acquisition excluding Victory, was essentially neutral to our overall adjusted EBITDA margins. Our 21% margins were even stronger than you might think when you consider that the losses incurred in our Panama City mill reduced our North American corrugated margins by 130 basis points in the quarter.

In our first fiscal quarter, we achieved record box shipments, which were up 13.5% year-over-year. Our legacy WestRock North American corrugated box shipments increased 3.1% year-over-year on a per day basis, and this was also a record. We've had a streak of 20 consecutive months of higher growth than the industry average. Over this time period, our legacy WestRock cumulative shipments have increased by 5.3% in contrast to the industry's growth excluding WestRock of 1.3%. To convert this to tons, this incremental growth over the industry average is equivalent to about 200,000 tons of consumption. This performance has been enabled by our differentiated strategy, product offering and approach to customers.

Let's talk about how our machinery solutions contribute to our differentiated strategy. The number of machines we've installed has grown from 2,100 to 2,500 over the past 20 months. Machinery supports customers consuming more than 1.5 million tons or approximately 1 out of every 4 of our 6 million tons consumed annually for the production of boxes. The 6 million tons includes KapStone, and KapStone Victory provide an expanded set of customers that can take advantage for differentiated product and service offerings.

In January, our North American corrugated box demand continues to be strong, with legacy WestRock box shipments organically growing at higher than 4% year-over-year, with most of the month complete. While our box volumes increased in the first quarter, we saw lower containerboard volumes in domestic and export markets. Export prices were materially higher than the prior year quarter, but they were lower than the September quarter.

Okay, I'm going to take a moment now and discuss our inventory levels. And to provide context, prior to the completion of acquisition of KapStone, we had no visibility to how KapStone operated their mill system, and this includes their approach to establishing their inventory levels. So quarter progressed, our mills ran well, we met our customers' demand in all 3 of our channels, and we gained visibility into our combined system supply and demand. As the quarter progressed, it became apparent we were counting more inventory than we needed. And in fact, at the end of December, we were holding approximately 100,000 tons of excess inventory.

So in this quarter, the current quarter, we're reducing our inventories to normal levels, we're matching our production to our customers' demand. In January, we initiated our inventory reduction with 35,000 tons of production slowbacks. The impact of this is incorporated into our guidance that Ward will discuss in a few minutes.

Let's talk in more detail about Panama City. I'm pleased to report Panama City returned to full production of containerboard during November. However, as we've reported, the damage has been severe, and we don't expect the mill to return to full pulp production until the end of the June quarter. And I'm thanking all of our employees, contracts -- contractors and their families throughout WestRock for your hard work and support in recovering so quickly from this natural disaster. It's been incredible.

Now to the financial impact, Hurricanes Lawrence and Michael impacted the quarter by $31 million or $0.09 of adjusted earnings per share. We expect to recoup a significant amount of these losses through insurance reimbursements in the coming quarters, net of the $15 million deductible.

Our Florence, South Carolina paper machine project is on schedule and on budget. We expect to receive our first equipment deliveries next month, and we continue to expect the project to be completed in the first half of fiscal 2020.

Now on to Brazil. The Brazil team delivered outstanding results, with adjusted segment EBITDA margins, 27.7%. Our new world-class Porto Feliz box plant is running, and we made our first box with our newly-installed flexo folder gluer last week. Our previous announced project of the Três Barras mill is well underway. As a reminder, we expect that when the box plant and mill projects are complete, they will increase Brazil's adjusted EBITDA by more than 125% and margins -- EBITDA margins, to over 30%.

Turning to KapStone. We've already made significant progress on integrating the KapStone operations into our North American Corrugated Packaging business. The mills and box plants have been successfully rolled into our management and operating business structures, and the installation of common systems and processes is underway. We've had some quick wins by leveraging the size and scale of WestRock's purchasing spend, and our commercial teams are making good progress. At the end of December, we've achieved a $30 million run rate of synergies and performance improvements. And we've been able to spend more time in the mills and box plants, and we've confirmed that the opportunities for productivity improvements that we anticipated at the time of the -- we announced the KapStone acquisition, are there.

We have proven capabilities to optimize the cost structure and operations of the large mills, as we've done with Smurfit-Stone, Tacoma and the SP Fiber mills. We're seeing the benefits of our expanded geographic footprint and enhanced product offering.

Victory Packaging has created opportunities for us to use their warehouse space to serve legacy WestRock customers. We expect to integrate more than 60,000 tons of annual box production to our Victory locations by the end of March. And we continue to expect to achieve $200 million in synergies and performance improvements by the end of fiscal '21.

In our Consumer Packaging segment, our sales of $1.6 billion represented an increase of 1% over last year. Our results reflect the flow-through of previously published price increases and productivity improvements that were offset by input costs and wage inflation.

We've seen demand growth in many end markets. This include food service, liquid packaging, beverage and retail food. Gains in these end markets are tempered by the ongoing secular declines of tobacco and media. Demand across our paperboard substrate is strong. CNK is tight, CRB demand remains good and SBS volumes are steady. Our paperboard backlogs were strong in the quarter. They're currently between 4 weeks and 7 weeks.

We're implementing the previously published price increases across each of our consumer paper grades in accordance with our contract terms. And as a reminder, Pulp & Paper Week's published price increases affect approximately half of our business, with the remaining business based on mechanisms not directly tied to these indices.

Adjusted segment EBITDA in the quarter was $216 million. Adjusted segment EBITDA was down $19 million year-over-year, primarily due to higher inflation and lower volumes that were partially offset by favorable price, mix and productivity.

We will install a new curtain coater at our Mahrt mill during March. And in April, we'll upgrade 1 of our 3 paper machines at Covington. And then in June, we'll replace the headbox at our Demopolis mill. These 3 projects have required comprehensive supply chain planning, including building inventory to support our customers in advance of the outages. The projects will moderate earnings in the second and third fiscal quarters. Once these projects are implemented, we'll operate a consumer mill system that will be lower cost, providing even a higher-quality paper for our customers.

Sales in our beverage business grew by nearly 10% year-over-year. Our beverage machine offering is an important part of our differentiated solutions that helps our customers grow their sales and reduce their costs. Our total installed base of approximately 1,000 machines supports about 330,000 tons of carton sales annually or 70% of our total beverage carton sales.

Many of our customers are interested in reducing or replacing their plastic packaging with paper-based packaging. We've implemented solutions in the food service and retail food markets to replace plastic containers with paperboard cartons and trays. We've sold machine solutions into the beverage market to replace printed film multi-packs with paperboard. WestRock's uniquely positioned to help our customers shift to more sustainable packaging with our diverse product and capability offerings.

Although we report in two segments, our strategy is focused on serving our customers with our broad portfolio of paper packaging, merchandising, machinery and supply chain solutions. We have more than 130 customers that buy more than $1 million from each of our segments. This accounts for approximately $60 billion or a little bit over 30% of our annual sales. The power of our broad portfolio enables us to combine WestRock's products and services, in ways that create unique winning solutions in the marketplace, ones that our customers value and ones that create value for our stockholders.

That completes my comments in the quarter. Now I'll turn it over to Ward.

Thank you, Steve. Turning to Slide 8, we outlined our key assumptions for our fiscal second quarter 2019 guidance. We expect adjusted segment EBITDA in the second quarter to be between $700 million and $735 million as compared to $733 million in our first fiscal quarter and $649 million last year.

Walking through the sequential bridge, favorable pricing and slightly higher volume in our Consumer segment will be partially offset by higher scheduled maintenance downtime, for a net increase of $10 million to $15 million. Pricing is higher due to the continued flow-through of previously published price increases.

Continuing down the sequential bridge. We expect the impact of a full quarter of KapStone's results to contribute approximately $45 million to $50 million in additional adjusted segment EBITDA.

In our Corrugated segment, we expect adjusted segment EBITDA to be negatively impacted by $20 million to $45 million due primarily to mill maintenance downtime and the actions that we are taking to reduce our inventory. Volumes across all 3 sales channels are expected to be stable.

We expect sequential inflation for the entire company of approximately $45 million, mainly due to annual salary and benefit cost increases and the restart of payroll-related taxes. Other input costs are moderately higher, primarily increasing virgin fiber cost as a result of the wet weather. This input cost inflation should be partially offset by expected lower natural gas prices.

We expect increased acquisition-related depreciation and amortization expense of $0.08 per share. In addition, interest expense will also be sequentially higher to account for a full quarter of KapStone ownership and higher interest rates, impacting the quarter by approximately $0.10 a share. We expect an adjusted tax rate of approximately 24.5% versus the adjusted 23.3% rate reported in the fiscal first quarter.

Considering our guidance for the second quarter, we now forecast fiscal year 2019 adjusted EBITDA to be approximately $3.5 billion, a slight reduction from our previous guidance. As our full year guidance would suggest, the second half of the year will likely be much better than the first, for multiple reasons. Our scheduled mill and maintenance outages across our system occurred during fiscal -- first through third quarters, and we have no scheduled outages in the fourth quarter. We will have rebalanced our inventory levels across our containerboard system.

Our Panama City mill is expected to be fully operational by the end of June and should no longer have a negative impact on earnings. We expect to realize the insurance recovery from lost profits in the second half of the year, which will run through our P&L.

We will reach full realization of the previously published PPW price increases across the consumer paperboard grades in the second half of the fiscal year. We will realize increased synergies from the optimization of the KapStone containerboard mill and box plant system. We expect that volumes in the back half of the year will be seasonally stronger, coupled with seasonally lower wood and energy costs.

We have adjusted our capital expenditure estimate for fiscal 2019 from $1.5 billion to $1.4 billion. With the completion of many of our strategic capital projects in fiscal 2019 and fiscal 2020, we will transition to our long-term capital expenditure run rate of $1 billion in fiscal 2021.

We have some additional full year assumptions in the appendix, and I will point out a few changes. We are completing our KapStone purchase price allocation, and our estimate for total company depreciation and amortization is estimated to be approximately $1.5 billion for the fiscal year, which is at the low end of our previous guidance range.

I'll now turn it back to Steve for some closing comments. Steve?

Thanks, Ward. I'm pleased with the progress we're making with our customers in implementing our differentiated strategy, the progress we're making to deploy capital to improve our cost structure and capabilities. We're doing all of this while paying a dividend that provides a 4.4% yield and cash flows that are providing us a path to return to our target leverage ratio.

We're motivated by the many opportunities in front of us. We're excited by the future, and we're engaged and proactively managing our challenges. We're clear on what we need to accomplish to deliver value for our customers and stockholders.

Now that concludes my prepared remarks. James, we're ready for Q&A.

Thank you, Steve. (Operator Instructions) Operator, can we please take our first question?

Your first question comes from the line of Anthony Pettinari from Citi.

With regards to the inventory reduction effort, you talked about I think, 100,000 tons excess inventories and taking down 35,000 tons in January in slowbacks. So just to be clear, will you lower another 65,000 tons in the course of the quarter? Or could that carry through to next quarter? Just trying to understand the timing.

Anthony, it's Jeff. So as Steve mentioned, we have a large mill outage in the quarter, so we have over 80,000 tons in maintenance downtime, and we've taken the 35,000 tons. We won't talk about anything we do in the future as it relates to other downtime. We will look at our inventories on the floor, there's a finite amount of space in our box plants and warehouses that we'll fill. And we'll continue to match our production to our customers' demands across all of our channels, so I'll say that.

Got it, got it. And then just on the medium price decline that was published in Pulp & Paper Week, is it possible to say what earnings impact that is, if any?

Sure. It's still Jeff, it's de minimis in our world, very small, under $5 million to the whole system. Very few box contracts are tied to it. And with our exposure in our containerboards, it's not that much on the outside for our medium, so very small.

Your next question comes from the line of George Staphos from Bank of America Merrill Lynch.

Two questions for me. Nearer term, you mentioned that box lines I think, are trending nicely into the fiscal second quarter. I think you mentioned up 4%, correct me if I'm wrong there. Can you provide some incremental disclosure in terms of exit rates on say, export volumes? What you're seeing in third-party domestic volumes, recognizing you had to take downtime, but what you're seeing in terms of shipments there. Then on the other hand, Steve, if we're having this conversation a year from now and you look back at what made for a more successful year or not, what is the one thing that you've got to manage to here? Is it supply relative to demand? Is it integrating KapStone? Because the industry is off to a kind of an interesting port right now, both within containerboard and the boxboard markets in terms of supply/demand.

Would you take the first half, Jeff, and then I'll respond?

George, I'll cover the exit rates and what we're seeing. So box remained strong. We're up over 4%, and we see our backlogs continuing, and we've been that way through the quarter and into this quarter. Ward mentioned earlier, sequentially flat we're seeing in our containerboard markets, and I'd say that for our kraft markets, both in export and domestic. What I would say is in February, what we've noticed in our backlogs, our orders were in much earlier, coming into the end of January for February. We We're coming out of the first quarter. I would say that we weren't as booked as early in our containerboard export in domestic. And going into the month, we're well above where we had seen the last 2 months in all of our backlogs with our containerboard.

George, you gave me one thing, I think that it may be difficult to isolate one thing. But I think for us, I think it's really, clear. I think we have to execute on our -- the plans that we have. We've got tremendous opportunities, internally. I think we've got tremendous opportunities with their customers, we've got tremendous opportunities to improve productivity. And so we just -- like one year from now, I think the key thing for us is executing on the plans that we have in place.

Your next question comes from the line of Brian Maguire from Goldman Sachs.

Just a question on again, back to the strong January and fourth -- first quarter of shipment trends. Just wondered, surprisingly strong relative to I think, the expectations and kind of where some of the fiber box association numbers were in November, the last ones we had. So maybe if you could kind of give any comments on what you think is driving that strength, or maybe any end markets where you're seeing a particular uptick in demand? And just sort of related to that, Pulp & Paper Week spoke to some discounts being made available in the linerboard market. Could you provide any color on why you think that might be the case, given these strong shipment numbers you're talking about?

Brian, it's Jeff. Lets me start with the box shipments and why we think we continue to grow this business. First, we're meeting our customers' critical challenges in the market, so we're delivering no-fail basics, which starts with perfect quality and on-time delivery. And then secondly, our value proposition of helping our customers lower the total cost, increase their sales, minimize their risk and also help them maximize their environmental footprint, we're delivering on those 4 pillars in our value proposition. We continue to differentiate with our machine sales, our enterprise sales. We can bring a lot to the table for our customers. So we continue to execute well across the system. Markets that we continually seed up, e-commerce continues to be favorable for us. Our bakery snack business is favorable. Distribution, our food process, pizza and everything that goes along with that across our system has been favorable. And we also have positive in our retail and consumer. So across the board, we continue to see opportunities to grow the business organically, and we continue to deliver on those no-fail basics, which has helped us stay strong. On the linerboard, so it's interesting. In the pricing, we've seen some pressures, Pulp & Paper published down on medium and there's some pressure. We're seeing some spot pressure on medium in the markets, but we have not seen the same in our linerboard. So our linerboard and box pricing, we haven't seen the same pressures. It's been predominantly around medium in some of our markets.

Okay, I appreciate that. And just as a follow-up for Ward, on the $100 million cut to the CapEx, I just wondered what's driving that? I mean -- you might have mentioned this in prepared remarks, but I might have missed it. Is that just being deferred out into 2020? And can you make a comment around 2021 being $1 billion? Or was that just the base before the strategic projects?

Right. So embedded in our $1.4 billion of CapEx this year, our original guidance was $1.5 billion, we simply took action to respond to the lower operating cash flow from the EBITDA reduction, and we have deferred CapEx. Embedded in that target this year, we will invest approximately $500 million across the strategic capital projects. That amount should drop in half to about $250 million next year. So when -- after we complete those projects, as we exit FY '20, I anticipate that FY '21 will return to our long-term ongoing CapEx investment level of $1 billion, of which 50% of that $1 billion is M&R and 50% of it is discretionary return-generating capital.

Your next question comes from Scott Gaffner from Barclays.

Jeff, just a quick question on the -- a follow-up on the box shipments for a minute. The 3.1%, by our math, includes about 2 points of acquisition volumes from Plymouth Packaging, is that correct? Or can you talk to us about what the underlying organic volume growth rate is there?

Sure, Scott. Now recall Box on Demand was January 5. So it's a clean, it's organic, and it's -- it wouldn't be 2 points Box on Demand, and volume is small in our world for shipments. But we had those as January 5 last year. So it's clean, it's organic growth.

Okay, perfect. That's a strong number. Can you talk a little bit about how that volume growth trended through the quarter? Because for you guys, it actually seems like after October, maybe picked up a little bit in November and December.

Sure. October was just under 2%, roughly. November, we were roughly 2.5%, and then we were up almost 6% in December.

Your next question comes from the line of Mark Wilde from BMO Capital Markets.

Jeff, I wondered if you can just talk about any shifts you're seeing kind of among your e-commerce customers in terms of the strategy or the types of packaging they use -- one of your competitors was dancing a jig on YouTube a couple of weeks ago. And that's a competitor that I think produces more lightweight containerboard, uses more mixed waste. So I just -- I wonder if customers are shifting what they expect or what they require?

I've just seen the jig. So in broad sense from our customer base, they're continuing to look for opportunities to drive out costs. I think that's one of the reasons we've been successful. We can do that in a lot of areas across our system and the enterprise, and then in our containerboard system, we are working with customers to reduce fiber, to optimize the packaging size. So the Box on Demand in our machine platform was giving us a tremendous opportunity to optimize the size and headspace in packaging, and that's a trend that's -- it's going to continue. And that's really been a trend in the business, whether that's e-commerce, beverage. Remember, trays had 3.5-inch depth, then they went to 3, 2.5, then they went to raft. So it's going to continue to look at how do you optimize package, how do you take waste out of the system. That's not a -- it's not a change that I would say is a surprise, and we are well positioned with KapStone and with our mill system as we look at optimizing grades to really help our customers meet their strength requirements and lightweights, where they need to. And then through our machine platforms, through Box on Demand and our entire enterprise, we're really, well positioned to meet any changing demand in the current status in the markets.

Yes. And Jeff, are you guys using mixed waste or are you looking at ways to use more mixed waste? Because it seems like not only the guy who did the jig but also some of the new projects that are coming out are being engineered to I think to use more mixed waste.

We're -- I'll put it this way. We're using as much as we can with the system that we have. So we've gone through what we believe is maximum right now in our system, and we are using as much as we possibly can.

All right. The last question I just -- on the capacity side, KapStone had not been running that medium mill up at Cowpens fully over the last couple of years and I just -- I'd like to get your thoughts on how you're managing that asset because it seem like it was already their swing asset.

So right now, we're managing it in the entire system, looking for supply chain synergies and -- in the entire system. I think it's too early to tell. We don't have everything on our system yet. One of the challenges is their east is really, manually scheduled and done, and then the west is on off division, but the systems don't sync up. So right now, we're trying to optimize the entire supply chain and put paper where it makes sense in our box plants to our customers, both domestic and export. So nothing really, to report there, Mark, except we're optimizing our entire supply chain.

Your next question comes from the line of Chip Dillon from Vertical Research.

If it's required for Jeff to take dance lessons for the next jig, I suggest that WestRock pay for it.

Jeff doesn't need lessons, he's very good already.

Jeff, I apologize. Apologies for underestimating your talent. I just wanted to ask you a question. I know you guys don't get into pricing and totally understand that. When I look at the guidance, it looks like, in essence, you're guiding to obviously, down from the consensus for the next quarter on an EBITDA basis, but the second half is higher. You're looking for something north of $2 billion. And is it fair to say that -- is there anything you can help us with? It would suggest to me that you're not expecting any material price change in that guidance up or down. Is that roughly fair to expect as you give us that guidance?

Chip, this is Ward. Let me just walk you through the elements and help you, and I'll answer the question. So why is the second half stronger than the first half, and I'm going to just kind of go through a laundry list, and it will be included will be your question. So we have 6 months' worth of KapStone versus 5 months in the first half. And we also have a seasonally stronger KapStone in the second half, just like our North American Containerboard business. So that contributes a meaningful amount of incremental earnings in the first half versus the second half. Panama City, in Panama City, it was a loss in the first quarter. it's going to be a -- it's going to generate a loss in the second quarter. We're going to be fully operational in Q3. We'll return to profitability. And we are anticipating the insurance recoveries for the business interruption claims that we have, and we've said that those will take place in the second half. Those two are -- those two items that I just described are very meaningful contributors to the earnings growth in the second half versus first half. And then we have no maintenance outages in Q4, they're complete in Q3, so our system's running full, both in Corrugated and Consumer. So we generate more productivity in the -- in Q4 and the second half of the year as compared to the first half. And then the actions that we talked about to rebalance our inventory levels in Corrugated, we're taking those actions in Q2, and we've given you the range of its impact on the quarter. And then we're back -- we have a maintenance -- a large maintenance outage in Corrugated in Q3, but then we're running full in Q4. So we have seasonally higher volumes across many of our businesses. We have initial synergy realization from KapStone across our businesses. We've got the full realization of the consumer PPW published increases as we go through the second half of the year. On our -- in Corrugated, we talked about our export pricing was down sequentially, Q1 versus Q4. And that will carry through into the year, but that's embedded into our guidance for the rest of the year.

That's very helpful, and just one quick follow-up. It seemed like from my -- from an outsider perspective that the export market was just going gangbusters into sometime just after Labor Day, maybe early October and then it stopped on a dime. And at least the fingers I saw were pointing more to China just not buying. Jeff, you mentioned that you saw backlogs, if I heard you right, have recently turned up nicely. Any help as to where that's coming from? Is it mostly coming from the Far East or from Asia? Or is it more broad-based, in terms of the export?

For us -- yes sure. For us, recall that 65% or so of our export is Latin America; 20% Europe; and then we have Middle East, Africa and Asia. So Asia for us is a smaller part. We didn't see a large drop-off in that area. There was some softening recorded in -- more through the third-party brokers, I'd say. So for us, that wasn't the large part, but in -- from the folks we dealt with in China, Asia, Middle East, there was softening in those markets reported to us from our customer base. And then our typical Latin America I think was stable. I'd say it was a bit down, but the backlogs were strong, and most of that is direct customers for us. And then Europe was a bit softer, as you mentioned, coming out of the quarter, the fourth.

Your next question comes from the line of Mark Connelly from Stephens.

Steve, Rock-Tenn had a pretty good box business but in the last couple of years, we watched those margins go down and stay down, even as the industry seems like it gets stronger and we get all these price hikes. Is that business just less attractive than it used to be? And what does it take for WestRock to get better returns and better margins there?

Mark, when you said box, was it -- I think you're talking about our Consumer business? Or carton business?

Yes. I think there are some puts and takes to what you've got included, but overall, I mean, the margins are a lot low lower than Rock-Tenn used to deliver.

I haven't done a comparison of what Rock-Tenn used to do. I think our margins are -- they are not as high as they are in the Corrugated business. We've got a significant focus on improving our cost structure and quality, and so you're seeing the capital projects that we're doing are really, designed to improve our cost structure over time. We don't talk about it on these calls, but the converting operations, we have a similar amount of opportunity. And I think the way our business is structured, we have, I'd say, our traditional carton business, which I think you've called the Rock-Tenn carton business. We also have our beverage business, and we have MPS. And between the 3 of those businesses, they are different with respect to markets. One will be more of a general carton market, then MPS is more call it, premium packaging and then beverage is focused on beverage market. We see opportunities to take advantage of the combined manufacturing footprint. And so the way I look at the business, Mark, the business is attractive. We've got a very good position and a very good competitive position. And I think if you go back and look at what we've done with the Corrugated business starting in 2011 and although we've seen the benefits of that, now we're kind of in a similar position now with our Consumer business. We're still in the early stages of let's call it, a multiple-year path to improvement, and we set that out at Investor Day. So I think the business is good. In fact, it's better than good. And I think we've got a good position on it, and we have significant opportunities to improve.

Okay, that's helpful. Can you just give us a sense now that you're not going to report merchandising display which -- that you shifted around, sorry. Can you give us a sense of how that performed? And how important that business is to your overall value-added strategy?

Yes so if you -- if I look at our fiscal 2018 full year sales, it's approximately $650 million in revenue. And I'll let Jeff talk about how it fits inside his system.

So the question of what does it do for the system, the merchandise display business, there's a lot of -- first of all, it's integrated with the Corrugated, so the board that they're using is internal for those displays. The -- specifically Wisconsin, some of the Westchester plants, we run a bunch of business in the Chicago BU up through that Wisconsin location. So those accounts were tied pretty closely. When we look at our graphic strategy across the enterprise between our preprint, litho label sales and our ability to differentiate is strong. So we're putting much more litho lam through those plants out of the box system into that system, so that's a synergy also. Now when you look at the innovation of that team and how they are able to meet markets for shelf ready, retail ready that we can do both in the box system and in merchandise, it's really appealing. And I think the other piece that we're working through now is how do we best look at different tiers or segments of display work to get into some of the, you might call it the smaller sale of the $5 million to $15 million annually, where we hit in the box business. And really, we think we can leverage that business to do it. But overall, strong design capability, strong innovation, great enterprise for us. I think they're a -- they're an entrée into places that a typical box sales rep wouldn't play. They get to marketing, they get to other people. It's a tremendous opportunity for the enterprise at large.

Debbie Jones.

My first question is on the Consumer business. I think there are a lot of things to be optimistic about. You keep delivering on productivity, price and mix, looks like it's moving up. It's a little clear to -- unclear to me as how to think about volume contribution for EBITDA for the full year. Is there a tipping point here with where it is positive? You talked about the strong backlogs and some of the strength in paid service, it's just unclear to me how that's going to trend throughout the year.

Debbie, it's Bob. Overall, our volumes are going to be up modestly for the year. Just maybe let me talk a little bit about the markets overall. As we indicated, our backlogs are strong in the 4 to 7-week range overall through the system. And just what we're seeing by grades, CNK is tight. And we're seeing good underlying growth into the beverage, some of that being driven by plastics replacements and the opportunities that we see there. CRB is also strong. We've seen some return to growth in the center of the store, which is very welcome. And then SBS, I would describe that as steady overall. We're seeing good demand. I think as you know, SBS is our most global substrate where we compete internationally in a number of end markets and where we see growth there is in food service, liquid packaging, health care and I would say, stable retail food. And what tempers our volumes overall is the secular decline that we continue to see in both tobacco and media and commercial print. So overall, I'd describe the volume outlook as being modestly up.

Your next question comes from the line of Gab Hajde from Wells Fargo Securities.

Jeff, maybe you could talk a little bit about the demand patterns and what you're seeing down in Brazil in the Corrugated business.

I can talk generally to their business. They are -- that business has continued to operate and outgrow the market. I think their markets right now are fairly stable. And as we build our new Porto Feliz box plant, they're looking to expand, move the Valinhos plant and looking to expand. So their business continues to perform extremely well and to grow year-over-year.

I think just to add, is that their box volumes were up year-over-year. I think with the new president there, I'm -- we're pretty optimistic about the future of Brazil from an economic standpoint. And I think we're really happy we're there. We've got a terrific business and we've got -- we're investing in the business. And I think the political environment there is positive to where I think, it will be a tailwind for us over time; whereas over the past few years, I feel like the economy has been more of a headwind.

Maybe Ward, for you, any thoughts on the OCC market? Or can you update us in terms of what you're seeing sort of in a real-time basis? It sounds like import permits were issued a little bit quicker than folks were expecting, but maybe the Chinese are holding off on putting in orders until after the Lunar New Year, I don't know. And then what's embedded in the guidance?

Yes, I'll talk about what's in the guidance, and then I'll let John -- Jeff comment on the overall markets. So when we gave guidance for the full year back in November, we said that we saw prices going down on the average of about $5 a ton for the full year, with some increase embedded in the second half of the year. So our current forecast for Q2 is relatively stable. We'll see pricing with Q1. And then we have a $10 increase sequentially from Q2 to Q3 and another $5 from Q3 to Q4. So our overall assumptions are very consistent with what we talked about when we set the original full year guidance. I'll let Jeff talk about the markets.

Now to your earlier point, we did see more permits. However, typically before the Lunar New Year, orders are placed so that they hit sure right after. We haven't seen that in our recycling business. And those permits are really going to the majors in China. We expect there to be some uptick, but again, we're not seeing a large influx in our recycling business to ship more OCC to China.

Your next question comes from the line of Steve Chercover from Davidson.

So we were a little disappointed in the Consumer Packaging numbers. I mean, it's hard to see how sales were almost flat and EBITDA was down in both dollar and percentage terms. So can you recover those margins? Is that just a function of the Pulp & Paper Week price increases flowing through? Or what other initiatives do you have there?

Yes, Steve, it's Bob. Let me talk just a little bit about the quarter overall. As we indicated, we had significant inflation in the quarter, so that definitely impacted our results for the quarter. Much of that was in wood, which was in the northeast and impacted our Covington mill in particular. But as we looked at our margin outlook overall, we would expect the full year to be at over 15%. And our margins are going to be tempered this year as we pointed out that we're making large capital investments, both in Mahrt and Covington to improve our margins. And then post those investments, we would expect that our margins will be above 16%. And as we talked about, we think there is plenty of opportunities to improve from there, particularly as we look at opportunities for further investments in our converting network to further optimize that.

Okay. Bob, actually I will stick with you. So if I understood, the display business is a $650 million revenue item, are the margins, like the EBITDA margins similar, like mid-teens that we should see migrate over to industrial?

No. They're more like converting margins. So -- and again, that was an approximate amount of revenue for the full year last year. And the margins -- when we talked about the margins in our merchandising display business on its own, it doesn't reflect the impact to the system of pulling integrated tons through the system.

Can you remind us what those converting margins would be like?

I'm sorry, they are -- they have been mid-single and sometimes, touching double-digit margins, just on the converting side. I think to emphasize what Ward said, you're kind of moving those margins over to Corrugated, but the board margin has been in Corrugated. And so that's just a more straightforward way, I think for us, to report business. And I think as Jeff expanded on the reasons that makes more sense in Corrugated for us now.

Yes, I appreciate that. And the final one, what inning would you say that the migration of plastic to paper-based packaging is in?

Steve, it's Bob again. Hard to describe it as an inning, but I do think it's early. As you know, it's an important issue with many of our customers. And we're working with many of them, they are interested in reducing their plastic or eliminating it. And just in the last year, we've seen tens of millions of dollars of incremental new business, directly related to plastics replacement. And I think over the next 2 to 3 years, it could meaningfully represent $100 million to $200 million of incremental revenue that we would integrate into our system. But it is certainly a top of mind item for our key customers, and we think we are very well positioned to work with our customers to help them reduce plastic or replace it in a lot of key markets, food service, beverage, food and in e-commerce.

Yes, I agree. I think you guys will be on the right side of history.

Your next question comes from the line of Mark Weintraub from Seaport Global.

Jeff, you -- I think you mentioned that orders were coming in earlier, and I presume that's for February. And is that normally indicative of what's going to be a strong shipment month? Or is that not a tie or link we should necessarily draw?

For Mark, I'll speak for us. For us, when we see the orders -- so based on our forecast, when we see the orders come in early, and if there are 50% or 80% going into the month in our containerboard space, that's -- it bodes well for our volumes usually.

Okay. So as of specifics, the containerboard as opposed to Corrugate boxes now? Or am I splitting hairs or not?

No, you're not. There's really for containerboard because the -- remember the lead times are a bit different. So our box lead times can be 3 to 5 days. Those are done really at the plant level. So those are coming into the plant from thousands of customers. And then our containerboard business, domestic and export in kraft, is really booked centrally from a customer service group and our planning group. So those are typically -- export is usually 30 to 90 days of bookings because of the sailings and the ships. And then containerboard, it can be a week or it can be a month, but the earlier those orders are coming in and we have visibility, the better it is to plan the system, optimize the trend of low-cost freight. And typically, that allows us better planning and the volumes are better able to project through the month then.

Got it. And Ward, you mentioned cutting back to -- from $500 million to $250 million on CapEx for the strategic budget. It's kind of a $1.2 billion, $1.3 billion number reasonable starting point for expectations on 2020 CapEx?

Yes. So just to be clear, we are investing of -- we are maintaining our strategic capital projects. And it's the estimated investment for this year, it's approximately $500 million. With the completion of the curtain coater and the Covington projects, the completion of Porto Feliz as we start to wind down, this is the heavy investment year for Florence. Três Barras starts to ramp up next year. The natural progression of these projects is that the investment level in FY '20 will go from $500 million to $250 million associated with those projects. And then again, our base capital is about -- is approximately $1 billion, and we have the flexibility to flex up or down depending upon the market conditions in -- on our other discretionary projects. But -- so $1.4 billion this year, the reduction in the strategic capital projects start to roll off next year. And then as we move it, we transition to our $1 billion run rate into fiscal '21.

Got it. Great. And then lastly, Bob, assuming success on the CNK's pending price hike, the spreads relative to SBS become -- actually becomes a premium to SBS. Would you be expecting customers to shift between grades on that? Or any color you can provide about how customers think about those two products against each other?

Sure, Mark. It's definitely a change. It's hard to say whether that new price relationship between the grades is sustainable, but I can tell you that the underlying demand drivers for CUK are very good with plastics replacement. And much of our CUK is positioned in applications, where we've got very strong performance specifications, both in beverage and food. So that actually makes it more difficult for customers to make the switch from CUK to SBS. We had a few examples of that, but it is very small. Over time, we could see a little bit more, but in general, the reasons why CUK plays where it plays in those end markets are because of the specification requirements. So I don't think that we'll see a lot of switching over time.

Yes, I'd probably just add on to what Bob said. We have had some switching from CRB to SBS, when CRB has been extremely tight. And I'll just reiterate, it's nice to have the full portfolio of those paper grades because we can work with our customers, because they need to package their product. And fortunately, we've got the flexibility to provide our customers with a lot of alternatives to that end.

And your final question comes from Adam Josephson from KeyBanc.

Just Bob, one more on the SBS and CUK topic. So obviously, you just announced the CUK increase. You recently achieved the CRB increase. You haven't announced anything on SBS, and I think you'd characterize SBS as stable earlier rather than strong. I think you characterized the other two grades as strong. So can you just help us with what exactly is going on in SBS, relative to CUK and CRB? Because there does seem to be a bit of a difference.

Yes, Adam. So as you know, again, the SBS market again is our most global substrate. We're competing with products all around the world. And it also goes into many end market applications more than the domestic CRB and then also CUK, which is largely focused on food and beverage. So in SBS, we're in food service, liquid packaging, health care, food markets. And a lot of what we're seeing in SBS is also being tempered again by secular declines that we see both in tobacco and commercial print. So overall, I would describe the SBS market as being flattish. So those are some of the dynamics, I think, that are at play between the grades.

And Jeff, just one more on the box demand situation. So I know you've been significantly outgrowing the industry, and kudos to you for having done so. Just based -- in terms of the industry data, all we have is obviously, through November. As you know, there's been a fairly decent slowdown in industry growth in recent months, at least through November. What would you attribute that to? Is that more the economy? Is it more that the e-commerce bump hasn't really been there? What would you attribute that trend, at least through November to?

Sure. I think you have to look at -- so in our world, the e-commerce bump was there. I think for the industry or business, I can't speak to the whole industry, it depends who your customers are, where you play. We're very strategic about how we partner with our customers, where we play and to help our customers win. So we want to win with winners and hit markets that we think we can grow and that are meaningful. Again, our machinery and differentiation -- ability to differentiate through the enterprise approach and through our businesses, helped us continue to grow. And in general, we didn't see, like I said, we were up each month. We didn't see economic slowdown in our business, so I can't speak overall for the industry.

There are no further questions at this time. I turn the call back over to the presenters.

Thank you, Shelley, and thanks for joining our call today. As always, reach out if you have any questions. We're always happy to help. Have a great day.

This concludes today's conference call. You may now disconnect.