Westrock Co

LSE:0LW9

Earnings Call Transcript 2020-Q4

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the WestRock Fourth Quarter Fiscal 2020 Results Call. [Operator Instructions] Please be advised that today's conference is being recorded.

Thank you. I'd now like to hand the conference over to your moderator for today, James Armstrong, Vice President, Investor Relations. Please go ahead.

[James Armstrong, Vice President, Investor Relations]

Thank you. Good morning, and thank you for joining our fiscal fourth quarter 2020 earnings call. We issued our press release this morning and posted the accompanying slide presentations to the Investor Relations section of our website. They can be accessed at ir.westrock.com or via a link on 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; our Chief Commercial Officer and President of Corrugated Packaging, Jeff Chalovich; as well as our Chief Innovation Officer and President of Consumer Packaging, Pat Lindner. 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 discuss during the call. We describe these risks and uncertainties in our filings with the SEC, including our 10-K for the fiscal year ended September 30, 2019, and our 10-Q for the quarter ended June 30, 2020.

In addition, we will be making forward-looking statements about the impact of COVID-19 pandemic on our operational and financial performance. The extent of these effects, including the duration, scope and severity of the pandemic is highly uncertain and we -- and cannot be predicted with confidence at this time. We will we be -- we will also be referencing non-GAAP financial measures during the call. We have provided a reconciliation 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.

[Steve Voorhees, CEO, President & Director]

Okay. Thanks, James. Good morning. WestRock's fiscal fourth quarter was highlighted by record sales and packaging across our business. We delivered solid operating results and exceptional cash flow that enabled meaningful reductions in both the amount of our debt and our leverage ratio. Explaining our performance during the fiscal fourth quarter begins with the incredible performance of WestRock teammates around the world. While the safety and health of our teammates has always been first and foremost, the past 7 months have been exceptionally challenging due to the COVID-19 pandemic and the impact it's had on all of our daily activities across the company. These activities include the implementation of safety protocols, the rapid changes in demands from our customers and the stress that all of us feel for the safety and well-being, of our teammates, our friends and our families.

We've accomplished many amazing things. And as just one example, I'll call out our teammates at our Demopolis, Alabama Mill, who've worked over 1 million hours without a recordable safety instance. For those of you involved in the operations of business, that is just amazing. And thanks to all of the WestRock teammates across the company for what they've done during these challenging times.

When we formed WestRock, we created a company that differentiates itself with a broad set of products and capabilities and partners with customers to meet their needs to grow their sales, lower their total cost, meet their sustainability goals and manage their risk. We've been very successful in doing this, especially over the past quarter. As we've said for some time, our focus has been on building our packaging business, and reducing our exposure to less attractive markets. For that reason, I'm providing additional perspective on WestRock's packaging business.

In fiscal 2020, WestRock's net sales were $17.6 billion. $12.5 billion or 71% of our sales were sales of packaging to a diverse set of attractive and stable end markets. The remaining 29% or $5.1 billion were sales of paperboard and pulp. And the $5.1 billion includes $1.9 billion of sales to lower margin SBS, export containerboard and pulp markets. Our packaging business is built on an outstanding platform that includes 31 mills and 230 converting facilities. Supply chain capability is critical. And our more than 200 packaging distribution sites are well-located to deliver product to our customers. We support 4,000 machinery installations in our customers' locations, further enhancing our ability to provide value to them. And WestRock's 50,000 incredible teammates make all of this happen.

We're well positioned to help our customers meet the growing demand for sustainable fiber-based packaging solutions. We're seeing increasing demand for functionality and value from our products and services, including the ingeniously designed e-commerce packaging that allows our customers' products to be shipped in its own container. This eliminates a redundant and wasteful additional box.

Demand is increasing for CanCollar Eco, a superior glue-free packaging solution used by Coca-Cola in Europe to replace plastic packaging that supports their initiative to create a world without waste. The glue-free quality of WestRock's CanCollar offering is an important differentiator for this product as some competitors use glue that transfers to the cans. Our sustainable solution provides a much better brand experience that's important to both customers and consumers.

Our products can also help consumers feel safer about their purchases. Our Bio-Pak Protect folding carton solution enhances food safety by enabling restaurants to seal delivery items in the store. This helps ensure that the product is not tampered with in transit.

Our packaging is helping connect consumers digitally to product information and promotional content. Our recent work with Domino's to educate consumers about the recycling of pizza boxes where they live demonstrates how digital content can enhance the customer experience. Our customers utilize our machinery solutions to lower their risk, improve their productivity and drive cost out of their packing lines. By combining our machinery solutions with our associated sheet and box offerings, WestRock provides a complete solution to our customers.

We had another year of growth in machine placements. During the fiscal year, machine placements grew by more than 10% to a total of more than 4,000 machines placed. The pandemic has accelerated our customers' demand for sustainable fiber-based packaging solutions, making now an opportune time to be at WestRock working with our customers. We help customers adapt to these new markets, and we're winning business as a result. We're doing this by combining our design capabilities, our portfolio of paper substrates, our world-class converting network and our packaging, distribution and other services to create packaging solutions that help our customers win in their markets.

In fact, our hot pipeline, that's business that we expect to onboard over the next 90 to 120 days, is very healthy. This indicates strong demand going into 2021.

Let's turn to our results for the quarter. We delivered another quarter of solid performance in a rapidly changing environment. WestRock sales during the quarter were $4.5 billion. Adjusted segment EBITDA was $721 million and adjusted earnings per share were $0.73. The fourth quarter's results benefited from an increase in packaging demand across both segments with our packaging volumes at record levels, up 6.9% sequentially and 2.4% over last year. We exported less containerboard and incurred lower recycled fiber cost, both of which positively impacted our results. These benefits were partially offset by 87,000 tons of economic downtime taken across our SBS system, higher labor and maintenance cost and the absence of the nonrecurring benefits that we received in the third quarter.

And as you all know, market conditions are changing quickly. Demand for corrugated packaging, containerboard and food and beverage consumer packaging is very strong. In contrast, SBS volumes remained soft due to declines in foodservice, commercial print and tobacco applications.

Importantly, we generated strong cash flow. In the fourth quarter, we generated more than $630 million in adjusted free cash flow, which brought our total to $1.15 billion for fiscal 2020. This is the fifth year in a row we've generated more than $1 billion in adjusted free cash flow. We reduced adjusted net debt by $578 million in the quarter, and more than $800 million during the fiscal year.

Let's go to Slide 7. The Corrugated Packaging segment delivered adjusted EBITDA of $513 million in the fourth quarter. This was up $31 million compared to the third quarter. This shows the momentum in the North American Corrugated Packaging business as box demand increased 5.1% sequentially on a per day basis. The adjusted EBITDA margin of 18.2% was in line with the prior quarter and North American corrugated adjusted EBITDA margins were 19.6%. As the quarter progressed, box demand increased, and we shifted containerboard tons from lower-margin export markets to serve higher-value box and domestic customers. As a result, our export shipments fell by 109,000 tons sequentially. With our growth in box shipments, our integration rate rose to 81% in the quarter. We're now selling every ton that we can produce, and we ended the quarter with tight inventories.

As corrugated box demand grows, WestRock is winning new business in the marketplace. Our box volumes in September were up 4%. This was in excess of the industry volumes reported by the Fiber Box Association. Our corrugated box backlogs are at record levels, and this signals strong demand growth into the future. Our daily box shipments in October were up between 8% and 9% from the prior year.

We're experiencing similar growth trends in our Victory Packaging business. Sales increased $47 million sequentially. Recovery in the moving and storage business and in auto parts sales fueled this growth, along with the growing need for distribution services for retailers and enhanced service requirements in the e-commerce channel. We're well positioned to serve this distribution market as retailers respond to e-commerce demand by shipping direct to consumers from their stores. We're pleased with the progress we're making with the further integration of Victory into our packaging business, and the ability it provides us to further differentiate our product and service offerings to a broad base of consumers. As a reminder, we supply more than 250,000 tons of boxes annually to Victory from our corrugated packaging system.

Our specialty kraft paper business is growing as the trend away from plastic bags and envelopes toward natural fiber-based packaging accelerates. In the fourth quarter, our shipments of kraft paper were 35,000 tons higher than the same quarter of last year. In Brazil, we're seeing very strong demand for containerboard and corrugated packaging. In the quarter, our packaging shipments grew 22% sequentially. We're well positioned to capitalize on the growth in the region with the ramp-up of our Porto Feliz box plant and the completion of the Tres Barras project in the first half of 2021.

We're realizing the benefits from the investments that we've made to make our system even more competitive and profitable. In October, we started up our new paper machine at Florence, and we're already making high-quality containerboard. We expect the machine to improve EBITDA by $30 million in fiscal '21, with a run rate of $55 million in EBITDA going forward. The Tres Barras mill upgrade is on track for full start-up on schedule in the first half of 2021, with the team in Brazil overcoming construction delays due to COVID restrictions in the area. I'm proud of our product teams who've maintained our focus on the execution of these important projects as they face challenges from the pandemic.

Our box plant in Porto Feliz is currently at 61% of capacity, and it's continuing to ramp up. This plant is expected to generate $20 million in EBITDA improvement in fiscal '21, with a projected full run rate of $30 million in incremental EBITDA a year.

Finally, we continue to capture KapStone synergies and we expect to achieve the full $200 million in run rate synergies by the end of this fiscal year. We've sustained our momentum through our systems integration through the use of digital capabilities, including augmented reality. We're now 90% complete with our system integration.

In total, we expect our opportunities to add more than $125 million in EBITDA in fiscal '21. And we expect a similar additional amount accruing to our benefit in fiscal 2022.

Turning to Slide 9. Consumer Packaging segment's adjusted EBITDA in the fourth quarter was $223 million, down $20 million from the third quarter due primarily to economic downtime in SBS. As many of you who follow our industry understand demand for specialty SBS has been declining, especially for the commercial print, tobacco, plate and cup stock markets. The declines in specialty SBS demand have accelerated with the COVID-19 pandemic. Commercial print demand continues to be down by more than 20% compared to the same quarter of last year, even while election and back-to-school promotions modestly improved demand sequentially. In foodservice cup stock markets, sales have declined by more than 30% sequentially.

As a result of this weakness and to balance our supply with our customers' demand, we took 87,000 tons of economic downtime in the quarter. This downtime supported the sequential reduction in our inventories of 72,000 tons.

In early October, we announced the removal of 200,000 tons of SBS capacity at our Evadale mill with the shutdown of one of our 3 paper machines there. The Evadale shutdown was originally scheduled for the end of the calendar year. However, we're currently producing 5,000 to 10,000 tons per month of containerboard at Evadale to help meet the strong demand in corrugated packaging. We may need to keep this up through March. This is a short-term measure to help address the very strong demand for containerboard. Our plans to remove 200,000 tons of SBS capacity are unaffected by this extension. The balance between our SBS supply and our customer demand is improving, and we plan to restart our idled paper machine at Covington later this month.

The lower margin from challenges of the specialty SBS and pulp business have masked the attractiveness of the rest of our Consumer Packaging business. The attractive portion of the Consumer Packaging business includes sales of paper and packaging solutions to the food, foodservice and beverage and specialty packaging markets. These solutions use our extensive range of paperboard substrates, and they're complemented by the broad set of value-added capabilities, including packaging design, material science, advanced printing and machinery automation. This attractive portion of our business accounts for approximately 80% of our segment sales and the vast majority of the segment's EBITDA.

The highest demand for sustainable fiber-based packaging is for the e-commerce, food, foodservice and beverage markets. We made good progress during the fiscal fourth quarter by increasing our consumer packaging converting shipments by between 2% and 3% sequentially and compared to last year.

The acceleration of the declines in demand for certain external SBS markets and the corresponding reduction to our projected future results caused the non-cash goodwill impairment charge in our consumer Packaging segment. As background, the majority of our carrying values were established by the accounting for the combination of Rock-Tenn and MeadWestvaco that formed WestRock. In this merger, MeadWestvaco was the acquired entity, and the goodwill was assigned to the combined units. The $1.3 billion noncash charge reduced the Consumer Packaging segment goodwill balance by 37%.

The segment has produced strong cash flow since the merger. In fact, we've generated $3.4 billion in pretax cash flow from the segment and this is measured by adjusted segment EBITDA minus CapEx. As demonstrated by our actions and results we're reducing our exposure to the less attractive 20% portion of our Consumer Packaging business, and we're focused on growing the more attractive 80% portion of our business that's well integrated with our paperboard mill system and also well integrated with our corrugated packaging solutions offerings.

Now I'll turn it over to Ward. Ward?

[Ward Dickson, Executive VP & CFO]

Thanks, Steve. Looking forward at our near-term capital allocation priorities, we are focused on investing in our business, and paying down debt while we -- continuing to return capital to our stockholders through our dividend. We expect fiscal 2021 capital investments to be in the range of $800 million to $900 million. This is higher than the estimates that we incorporated into the pandemic action plan due to capital investment projects that we have today to respond to specific growth needs.

During fiscal 2021, we will complete our Tres Barras mill upgrade and start to reap the benefits of our strategic capital projects in our mill and converting systems. Longer term, we anticipate a return to capital investment levels between $900 million to $1 billion each year. At this level, half will be invested in maintenance projects, and the other half will be invested in return-generating projects that reduce our cost and enable us to grow with our customers.

As we continue to generate cash, pay down debt and reduce leverage towards our targeted range, we expect to return more capital to stockholders through increases in our dividend and opportunistic share buybacks. We also see the potential for M&A opportunities that are focused on our packaging businesses.

We continue to use our strong cash flow to pay down debt and strengthen our balance sheet. During fiscal 2020, we reduced adjusted net debt by $813 million. As shown on Slide 12, we have very little near-term debt maturities and approximately $3.6 billion of available committed liquidity and cash, a solid investment-grade credit ratings and our pension plans are overfunded.

Turning to guidance. We expect first quarter adjusted segment EBITDA to be between $630 million and $660 million, with adjusted earnings per share between a $0.46 and $0.54 per share. I will provide some sequential quarter guidance commentary to help you with your models.

Consistent with prior years, we anticipate a sequential decline in sales and earnings from the fourth quarter of fiscal 2020 to the first quarter of fiscal 2021. In Corrugated Packaging, we expect continued strong box growth with higher per day shipments, but with 3 less shipping days in the first quarter versus the prior quarter. We anticipate the normal seasonal sequential volume declines in many of our businesses, including merchandising displays, Victory MPS and food and beverage.

While demand remained strong in Brazil, we are executing a significant outage to support our Tres Barras mill upgrade. This project is on track for completion during the first half of fiscal 2021.

We expect higher natural gas and freight cost as we enter the winter months, along with increased health insurance costs prior to the reset of employee deductibles that occurs at the beginning of the calendar year. In addition, our short-term incentive payouts were below target for fiscal 2020 as part of our pandemic action plan, and we will begin accruing fiscal 2021 at a higher targeted base level.

As markets continue to change quickly due to COVID-19, we are not providing full year revenue, adjusted EBITDA or adjusted free cash flow guidance at this time. In fiscal 2020, we demonstrated our ability to adjust our operations to market conditions and continue to generate cash. With the backdrop of improving demand conditions, along with the completion of our strategic capital projects, and the benefits of our pandemic action plan, we are confident in our ability to continue to generate strong cash flows, reduce debt and make meaningful progress towards our leverage target. Now I'll turn it back over to Steve for closing remarks.

[Steve Voorhees, CEO, President & Director]

Thanks, Ward. Our fiscal 2020 presented new challenges for our company. I'm incredibly proud of how we're managing through these times, and I'm grateful to the WestRock team that's delivering for our customers each and every day.

The demand environment is improving. We see this particularly in food and beverage and e-commerce markets. We have additional growth opportunities with our e-commerce platform with innovation in fiber-based, sustainable packaging solutions. At the same time, we're committed to constantly identifying additional opportunities to improve our performance. This includes productivity improvements, capturing synergies and projects that enhance the efficiency of our operations. We're capturing the benefits of our strategic capital projects, and we'll continue to do so as we complete the Florence and Tres Barras projects.

We exited fiscal 2020 with strong free cash flows. We're generating free cash and that's certainly an ongoing priority for WestRock. As we execute our strategy, we'll reduce debt and return to our target leverage ratio.

WestRock is well positioned to take advantage of current and changing market trends with our broad portfolio of paper and packaging solutions, machinery offerings and innovation capabilities. We're partnering with our customers to address their critical customer challenges, whether that's the need for sustainable fiber-based packaging or complex supply chain solutions that meet today's changing market demands. WestRock is the premier partner and unrivaled provider of sustainable, winning solutions, delivering value to our customers, our teammates and our stockholders. That concludes my prepared remarks. James, we're ready for Q&A.

[James Armstrong, Vice President, Investor Relations]

Thank you, Steve. [Operator Instructions] Operator, can we please take our first question?

[Operator]

[Operator Instructions] George Staphos with Bank of America.

[George Staphos, Bank of America]

Congratulations on the progress. Also, congratulations to Jim Porter on his retirement. I guess my first question, Steve, you talked about the hot pipeline and you offered some positive qualitative commentary. Can you talk a bit further either in quantified terms, you obviously gave us the shipment numbers to date in the quarter, but what you're seeing in the pipeline and how it translates to '21?

Relatedly, I think machinery installations were roughly up about 100 from fiscal 3Q to fiscal 4Q. What, if anything, are you seeing out of COVID that's driving different types of purchases and installations versus what you were seeing previously? And then I have one follow-on.

[Steve Voorhees, CEO, President & Director]

Okay. George, Jeff's our Chief Commercial Officer, and is very well in tune with that. So I'm going to ask Jeff to respond.

[George Staphos, Bank of America]

Sure.

[Jeff Chalovich]

George, so I'll start with the pipeline. So we track our pipeline cold, warm and hot, and we have a flow-through rate across the business, the entire enterprise. And so we target a certain amount in our hot pipeline, and we know that on average, 80% or so that we close in the 90 to 120 days. And so that informs what we believe is coming on in business from where we are in the selling cycle.

So those, like I said, are about 80%-plus close rate across the whole enterprise. So that allows us to plan both capital, from a capital standpoint of what we need to add or shifts or whatever the business is coming in. So we have a good look into the quarter and then beyond. So 90 days to 120 days.

On the ALDI machinery, we continue to see growth and you're right, we had about 130 incremental ALDI machines. So we're continuing to see customers -- COVID, partly, I think customers are looking at, number one, labor and then how do you separate people in the back of the shop. Hence, there's lots of shops that have people still manually packing boxes and on top of one another. So it gives an opportunity to spread out and move apart.

And then also as we're looking to reduce cost, gain productivity and people are harder to get into the plants, our machine platform has given us a great opportunity to do that. And we're also seeing good opportunities in innovation with our machines. So we've had -- our pipeline demand business, we've come up with a new pouch design for packaging. And we're looking at either ship-from-store or we're augmenting our box-on-demand business and actually adding the ability to pre-make mailers and then use Victory Packaging to distribute. So we have a large customer, who's one of the largest retailers in the world, who's looking at moving out of plastic mailers into single-face mailers.

And so we've augmented our box-on-demand corrugators to be able to score in fold tubes from sample and then we glue them, put tear tape on them, we're able to label them. And we can do that in-store. So one of the largest trends in e-comm is shipped-from-store for our customers. And then also we're able to use our Victory Packaging to help distribute.

[George Staphos, Bank of America]

Jeff, my follow-on is around the notion of how much incremental growth do you think has been created -- or maybe you don't agree with that view. From COVID, from e-commerce, the question behind the question being hey, look, we're all doing things differently now than we were 9 months ago, 1 year ago, and it would -- it might have created an embedded incremental demand rate for corrugated that didn't exist before.

If you agree with that, what would your customers say, what would you think that incremental is? And maybe you disagree, maybe you think this is a one-and-done when we all get back to normal, when there's a vaccine, et cetera, we go back to normal growth in corrugated of, I don't know, 1 point, whatever. And we're looking at tougher comps in the future. How would you have us think about that?

[Jeff Chalovich]

Thanks, George. So I think what we're seeing in the e-commerce channel is growth that's accelerated. If you look at what was projected for e-commerce to be part of the retail channel. So we schedule to be, if you look at Kantar retail, they had 23% of the sales by 2025 to be from e-com. I see that accelerated, and that still will be the largest retail channel. So that would be in retail. So we see an acceleration, and that could be by 2022, 2023 at this point.

And I think you'll see that continue and it has been a positive for box demand. Now what percentage, it's hard to tell overall because there's puts and takes in that, right? As you go to SIOC packaging, you have some boxes move to envelopes, but it's definitely added share in the corrugated space for us. And we see the trends, especially the trends that I just talked about, buy online and pickup in store is the largest growing, subscription, packaging.

And then the ship-from-store, when you think about what everybody is talking about last-mile shipments. Well, there's a bunch of places that are last-mile shippers that are called retail stores. And so the retailers are now looking at how they can best serve customers and we're uniquely set up to do that because we have a machine platform that can fit in-store or we have a distribution network to help customers with their ship-from-store without having to pile up the back of their shops.

Well they don't have a lot of room in their stores. So they're moving from ship-from-DC into ship-from-store, and I think that's going to be a positive trend in corrugated, not just for boxes, but for things like the pouches and the mailers that we're making.

[Operator]

Mark Weintraub with Seaport Global.

[Mark Weintraub, Seaport Global]

I actually wanted to follow-up on George's question. It's just is obviously hugely important if we can sustain these -- I mean last 2 months, it was 4 -- close to 4% for the industry, and you're talking about 8 -- 7% to 8%, others talking really big numbers as well to kind of understand whether this shift is sustainable going forward.

And so thanks for all the color on the e-commerce. Are there other factors that you would highlight? And again, coming back to this notion as to whether or not this is a step-up and that we can sustain it at these levels and build from here or whether or not there are maybe other things going on that would suggest being cautious about extrapolating in that fashion?

[Jeff Chalovich]

Sure. So I think that what we've seen in our -- so we finished October up 8.6% per day. And so e-commerce was a large part of that. But we also had continued recovery in markets affected by COVID. So our protein business came back. Our industrial markets came back. Distribution, retail, processed food is still strong in our bakery business and beverage. So all of those markets have had positive acceleration coming out of COVID.

To extrapolate from that, what's going to stay and what's not, at 8.6% to almost 9%. I don't know that I would project that. But I think from our pipelines, the new business that we have, we do see positive growth in our business. And the consumer changes to back to middle of the store, some of the frozen products, some of the fresh. Just to give you a point, a data point, the e-commerce buy online, pickup in store. Last year, in 2019, 12% of consumers who bought online and picked up in store, well that store went into the store. This year, it's up to 20% of people who buy online and pickup in store even with COVID.

So I think there's some pickup in some of the middle of the store, some of the frozen and I think some of those trends can last. But it really depends on what happens with COVID and what new normal becomes. But we're seeing positive trends in our customers who continue to innovate their products are seeing pickup, certainly.

And then do you have people who don't let their stores of cleaning products, tissues, tiles, paper tiles, those things go back? And I think our customers are changing a bit to just-in-time inventory to a more sustained inventory levels, so that you keep up with some of the demand. But it's hard to project beyond the quarter or 2 that what the growth is going to be long term, Mark.

[Mark Weintraub, Seaport Global]

Okay, great. And one quick follow-up as well. So the type of thing you're doing at Evadale where you're making some containerboard. It -- should we view that as purely an emergency measure given the circumstances? Or is this kind of a feasible economic strategy to swing at a mill like Evadale on a go-forward basis?

[Steve Voorhees, CEO, President & Director]

Mark

[Jeff Chalovich]

Now your first comment, was it -- is it -- well I'm sorry.

[Steve Voorhees, CEO, President & Director]

Yes. All right. Go ahead, Jeff.

[Jeff Chalovich]

Yes. No, it's a short term. It's really to get -- help us get our inventories back to speed. The cost profile is not for the containerboard. So that's a short-term emergency.

[Operator]

John Rider with Stephens.

[John Rider, Stephens]

This is John on for Mark. So around SBS, how much in price at this point, the prices have to rise for you to earn cost of capital in that business, assuming the cost side doesn't change? And can you tell us what you're assuming just for your freight expectations in your outlook?

[Patrick Lindner]

So John, this is Pat Lindner. So regarding price in SBS, I really can't comment on any forward-looking pricing actions and how that would impact the market. So I really can't comment on that. On the freight question, I'll turn that over to Ward. Ward, if that's okay?

[Ward Dickson, Executive VP & CFO]

Sure. So we are -- as we look into our outlooks sequentially from Q4 to Q1, we're anticipating about a -- roughly about a 2% increase in our freight costs. And then as we look out through the whole year, we see something similar to that right now because we have some pressure on short-term spot rates, but we're only exposed to the spot market for less than 10% of our trucking demand, and we also have a projection of declining diesel costs. So the freight expectation is not outsized as we look for the full year.

[John Rider, Stephens]

Okay. That's helpful. And then with the machine closure at Evadale, what do you expect your overall paperboard end-market mix to look like between carton liquid packaging, foodservice and others? And what will you do with the extra pulp capacity at Evadale?

[Patrick Lindner]

Yes. So John, this is Pat again. So we really -- we don't expect the mix in the SBS product line to shift significantly. We were experiencing a lot of economic downtime. As Steve shared, we took about 87,000 tons of economic downtime at Evadale or in the SBS system overall, I should say, in the quarter. And there's about 156,000 tons of economic downtime, as you can see in our shipment data in the charts that we prepared and shared with you.

In addition, last year, we produced a significant amount of pulp increases there year-over-year. So the way you can really think about it is that we had a lot of economic downtime and in order to -- as well as production on pulp and so in order to match our supply with our customers' demand, we figured that we decided that it was the right move to take 200,000 tons of capacity, SBS capacity, out of our system, that's about 10%. But the mix overall of what will serve our customers with stays relatively the same.

[Operator]

Anthony Pettinari with Citi.

[Anthony Pettinari, Citi]

Ward, in containerboard, there's a price increase that's been announced for November. And I'm just wondering if you could talk about historically how long it's taken for the price increase to flow through on the box side.

And then maybe building on some of your earlier comments, how you just sort of characterize the current market environment versus maybe previous hikes from previous years?

[Jeff Chalovich]

Hi, it's Jeff. So we did communicate to our customers a $50-a-ton increase on containerboard and boxes. I expect there won't be much in this quarter. And then the flow-through will happen in the first 2 quarters of the calendar year is typically how it will start to flow through.

[Anthony Pettinari, Citi]

Okay. And then just in terms of how you think the kind of market is positioned maybe versus previous hikes that you've seen?

[Jeff Chalovich]

So the market -- I'll say, the market conditions for our Box business and for WestRock is our inventories are lower than we want. Our box volumes are at record levels. We're a record Q4 record in October and now heading to record shipments per day in this quarter.

So for us, the -- it's a good position for our demand. Our supply is tighter than we want right now. So that's some of the things we're doing with Evadale. The question really is the unknown of the pandemic. So we've never been in a market that had a pandemic in. At least I've never been. So it's hard to take something that's in the past and put it into the future with what's going on with the pandemic, so I can't speculate on that.

[Anthony Pettinari, Citi]

Okay. Okay. That's very helpful. And then just a quick follow-up on consumer. It seems like CUK or CNK demand has been very strong and pricing has been good relative to SBS over the past few years. Is it possible or desirable to move customers from CNK to SBS to tighten up your system? Or is that possible or not possible for commercial or technical reasons?

[Patrick Lindner]

Yes. Thanks for the question. This is Pat. The -- so as you mentioned, CUK or CNK for WestRock is -- has been strong, driven really by the beverage as well as the food markets for pantry restocking and pantry load up. As far as specifically, your question around CNK moving to SBS, certainly, there has been -- there had been examples of moving across different substrates like that.

But I would say that what we try to do at WestRock is we try to really understand what our end-customer demand is and what they prefer and what they can use most effectively in their products. And so there are situations where our capacity, and obviously, as we've shared before, we do have some open time in SBS. So if we can do that, we're going to do that. But it really needs to meet the end-customer demand such the SBS works for their application. And so certainly looking at it, but following our customers' lead.

[Operator]

Gabe Hajde with Wells Fargo Securities.

[Gabrial Hajde]

I hope you and your family is well. I was -- I know you guys are not formally providing free cash flow guidance, but just if we can try to maybe talk about some of the moving parts. I think directionally, CapEx would be down $125 million.

You talked about $125 million of known EBITDA improvement stemming from capital investments. I think working capital was a pretty big drag this year. I guess is there any reason to believe that it wouldn't be up in fiscal 2021? And then can you remind us of any other moving parts that I might be missing?

[Ward Dickson, Executive VP & CFO]

Sure, Gabe. This is Ward. So we have a lot of confidence in our ability to generate strong cash flows. And so you hit on some of the key elements. We've got -- at the midpoint of our CapEx guidance for the year, that's $125 million to $130 million reduction. We still have some of the benefits of the pandemic action plan. So as you'll recall, the FY '20 short-term incentive payments were actually paid with stock via cash, and that actually occur -- would abnormally have -- that payment would have normally occurred in the first quarter of FY '21, if it were a cash payment.

I would really point also to the fact that if you just look at our -- the relationship between EBITDA and adjusted operating cash flow is like 76% or 77% in FY '20. And the only other item that should -- we had a lower cash tax rate because we had high capital investments. We got some larger R&D credits. So our cash tax rate was actually below 20% in FY '20. Barring any policy changes, I would anticipate that, that cash tax rate would move closer to the book tax rate in FY '21.

So really, the starting point for the discussion is EBITDA. The positive drivers related to EBITDA is strong supply-demand environment, the contributions for the strategic capital projects and synergies that contribute to incremental earnings and then lower Capex, and we still have some of the other elements of the pandemic response plan. So we have confidence that we can generate strong cash flow during the year despite some of the uncertainty related to what's the pandemic going to do in terms of the demand environment over the course of the full year.

[Gabrial Hajde]

And then second, I guess on the CUK side. I don't know exactly where utilization rates are for you guys there, but it feels like with all the at-home consumption, you might be a little bit constrained, and like you said, trying to test some customers on SBS. Do you have any plans or the ability to maybe eke out a little bit more capacity for that particular paper grade?

[Patrick Lindner]

Yes. So thanks for the question. This is Pat again. So as we mentioned before, CUK or for WestRock, CNK has been strong. Our operating rates have been in the high 90s, and our backlogs are in the 4-5 week range. So and we did notify customers of a $50-per-ton price increase just recently. So good strength in that market-driven by beverage as well as food.

As far as changing capacity or increasing capacity, I really can't comment on a forward-looking basis around our capacity plans, but I will say that we're always looking at opportunities to meet our customers' needs with the right products. And so we have opportunities to do that as we identify and we'll certainly try to move in that direction, but I can't share any specific plans on that at this time.

[Operator]

Mark Wilde with BMO Capital Markets.

[Mark Wilde, BMO Capital Markets]

Yes. I'd like to just come back to kind of the EBITDA outlook for the next couple of years. If I go back in time over the last 4 big deals you've done since 2011, you've pointed the cumulative EBITDA synergies and cost improvement of $1.8 billion. And this last year, you only did about $2.8 to $2.9 billion.

So it seems like there's leakage going on somewhere. And so what can you do to give people confidence that these EBITDA improvement numbers you've got out there for the next couple of years are really going to flow through?

[Ward Dickson, Executive VP & CFO]

So Mark, this is Ward. I'll start, and then I'll see if Steve wants to add anything to it. I think one of the things you obviously have to think about every year in a manufacturing business is you've got cost inflation. We have wage and benefit inflation between 2% and 3% every year. And if you look at our entire cost profile, we've got commodity cost and energy cost, transportation cost inflation each year.

So we have to generate productivity around -- I would say, on a normal basis, around $250 million approximately to offset the impact of inflation. So that's one of the things that you need to look at. And then clearly, the other key EBITDA driver that we have is volumes and the pricing, the supply-and-demand conditions that we have across all of our businesses. And the pricing environment that comes with it. Steve, do you want to...

[Steve Voorhees, CEO, President & Director]

Yes. I'll just add, Mark. Our business is a manufacturing business and cost increase, our customers demand greater value. And so it's a competitive market. And so we've used the transactions and the synergies to build the platform that we have, which I think is generating and has generated very strong, consistent cash flows. And I think we said a couple of times, 5 consecutive years of $1 billion in free cash flow, and that's with implementing a very strong capital program to improve the performance of the business.

[Mark Wilde, BMO Capital Markets]

Okay. I'm just raising the question of -- if we talk about these EBITDA gains, if they're just going to be offset to some degree by inflation or other issues, we need to think about them a little differently. My follow-on is a congratulations to Jim Porter, but then I just wanted to talk about the Southern Container business because both Jim and Jeff came over with Southern Container.

I remember when you acquired it in early '08, it had EBITDA margins in a sort of -- on an LTM basis of about 27% or 28%, if I remember correctly. And at that preceding year, the liner price was $532 in Pulp & Paper Week and the OCC cost was $112. So this last year, the liner price is about $200 higher. The OCC price is $75 cost, just $75 lower. And if we look at the margins, the margins for the business as a whole are down significantly from what Southern used to put up. What's the -- how do you explain that mismatch?

[Steve Voorhees, CEO, President & Director]

Okay. I'll try, and then I'll give Jeff an opportunity to follow-up. But Southern Container is an amazing business. And I think in addition to Jim Porter and Jeff, Tom Stigers is with us, and they've been incredible adders to the entire WestRock management team. Now Southern Container was now had Solvay, which is -- continues to generate fantastic results. And then I think you mentioned Smurfit. In 2011, I think Smurfit's margins, at the time we acquired it, it was a -- one that has several-million-ton system, and its margins were 12%, I think, the first year. And so you take 12% with very large volume and Southern Container's Solvay was, well at the time we acquired it, I think it was about 800,000 tons.

That gets higher than that. And so put that together and you end up with something lower than we're making now and the corrugated management team over the course of 2012 to now, I think, has generated incredible results. And so our margins are now very competitive with the leaders in the business, and we're doing that with a mill system that we've invested in.

It's operating very well, but I think we started with a mill system that was underperforming. And we've invested in the entire system, the box plant and the mill system to, I think, have a incredible business in corrugated. Now Jeff, do you like to add anything?

[Jeff Chalovich]

I'll just add a few things. Mark, it was -- Solvay was a huge part of it. We were highly integrated. We had 13 well-capitalized box plants. Eastern regional, so close proximity to the mill. No export business, just a good domestic customer base with a strong box base that we still have today.

And as Steve said, after the Smurfit acquisition, our margins in the business were 12.5% or 12.7% the first year that I came into the container business, and we've gone up to the 20% range. So it's a much different business. We were less probably 2% of the market, and now we're 24% of the market and EBITDA margins close to 20% and continuing to improve the business. So I think it's a good story overall.

[Operator]

Steve Chercover with D.A. Davidson.

[Steve Chercover, D.A. Davidson]

I'm interested in the Evadale -- or Evadale and the Covington situation. So first of all, what's the tonnage of the Covington machine? And since Jeff has thrown cold water on EBITDA potential for containerboard, is it conducive to CNK? And what would that take beyond turning off the bleach line?

[Patrick Lindner]

Yes. So thanks for the question, Steve, this is Pat. So Covington is about half of our SBS capacity or think about 1 million tons. We -- due to the soft conditions in commercial print, tobacco and others, we have been taking economic downtime at Covington. We idled the C8 machine as we matched our supply with our customer demand. And as Steve mentioned in his prepared remarks, we have -- or we are planning at the end of this quarter to restart C8 because we now believe that our -- in order to meet our customer demand, our supply and demand is relatively balanced.

Regarding your question at Evadale, we're always looking for opportunities, as I mentioned before, to utilize our assets in the most effective way and producing linerboard at Evadale on our paper machine is one example of that. I really can't comment on capacity changes or capacity increase or decrease plans in our future in a future stage, just not allowed to comment on that at this time. But we will continue to look for ways at Evadale and other locations to meet our customers' demand as they continued to increase. And certainly where you're seeing it pay for us is one of those areas is very strong.

[Steve Chercover, D.A. Davidson]

Well, I appreciate that, but I just wanted to know the capacity of the C8 machine. And then from a technological standpoint, is it feasible for the machine at Evadale to make CNK?

[Patrick Lindner]

So the C8 machine at Covington is about 15%, maybe 20% of the capacity that is at Covington. So that maybe gives you an idea and it relates to the economic downtime that we had in the year. And I guess from -- as an innovation person, innovation-oriented person, I always say that some

-- anything is possible.

And so we'll look at all the different options that we have, including making different substrates at all of our mills. But exactly what that would look like from a return on investment and how we would accomplish that at this stage is just uncertain, but we'll continue to look at it, that and several other ways to meet our customer demand.

[Operator]

Paul Quinn with RBC.

[Marcus Campeau, RBC]

This is Marcus on for Paul. Maybe starting on the Brazilian box business. Brazilian box demand has clearly been quite strong. Can you talk a bit about what has been driving that demand growth? And maybe more broadly, how does that Brazilian corrugated business fit into your strategy longer term?

[Steve Voorhees, CEO, President & Director]

Let me start with Brazil has been a fantastic business for us for a long period of time, like we've been there since the 1950s. It's an integrated corrugated packaging business, and it's worked extremely well for us. It fits because it's in a very low-cost fiber-based region of the world. And it fits because the business is the same as business that we have in North America.

And culturally, it's a big adder for us. We're able to exchange ideas with both customers and culturally within our organization to improve the overall performance of the business. Jeff, I don't know if you have any color on the increase in demand. The market has been exceptionally strong, I think, with -- on COVID recovery. But do you have anything to add?

[Jeff Chalovich]

Yes. Sure, Steve. It's the pro -- or the protein business is extremely strong, going very well. And then it's really in the food, beverage, retail. There's not really an e-commerce business in Brazil at this point. So it's really the other typical consumer non-durable businesses that are really strong and, again, tight market positions there also.

[Marcus Campeau, RBC]

All right. That's helpful. And then maybe on inventories, they appear to be quite lean right now. How do your containerboard and SBS inventories compare to normal levels?

[Steve Voorhees, CEO, President & Director]

And Jeff as our containerboard inventories were very tight -- I mean Pat. And I think we've been reducing our SBS inventories and our paperboard inventories. So I think you saw -- you may have seen in the prepared comments, we reduced home pretty significantly this past quarter. So we're reducing them to levels that we think are appropriate for our operations.

[Operator]

Adam Josephson with KeyBanc.

[Adam Josephson, KeyBanc]

Jeff or Steve, in terms of the price -- the containerboard price increase, can you talk about how much of your containerboard and box business is tied to changes in the published RISI index? And can you talk about whether you want to increase or reduce that percentage anytime soon?

[Jeff Chalovich]

Adam, it's Jeff. So the -- there -- the contracts that we have differ. There are index -- customers were tied to the indexes. And that's the majority. It's north of 50% for us. We have customers that we're working with some of our large customers that are more cost model, but they still have indexed pricing to a certain extent, but it varies by customer.

And then I think the overall view is what's -- we work customer-by-customer on what's the fairest way to create value for our customers and for us with price movements, value added. So it's not a -- we're not painting with a broad brush. We do that really, it's a customer-by-customer exercise.

[Adam Josephson, KeyBanc]

And Steve, just broadly, you've talked about the benefits of being a one-stop shop for your customers for both boxes and folding cartons. And just in the context of how well the corrugated business is doing and the extent to which the consumer business is struggling, how would you characterize how successful that strategy has been? Or with the benefit of 2020, would you have gone about building the portfolio any differently? Any thoughts there, I'd appreciate.

[Steve Voorhees, CEO, President & Director]

Okay. Thanks for the question. I wouldn't have done anything differently. I think we're performing exceptionally well. I think it's -- frankly, from a communication standpoint, the way we've communicated about both corrugated and consumer, I think, has gotten in the way. It literally has masked the success that we have because corrugated is somewhat diluted by the sales we make of lower-margin export containerboard.

And as we've seen in consumer, and I'd invite you to go through our prepared comments because the progress we're making in the packaging side of consumer packaging has really been quite good. And the margins, if you take out the, call it, specialty SBS and pulp, are actually quite good. And then -- but we end up reporting each quarter the 13% to 14% EBITDA margins, when, in fact, the packaging side of the business is performing very well relative to just about any measure.

So I think one of the reasons we included the packaging results is we want to communicate to investors that as a packaging business, we've got an unrivaled platform from which to work through -- work with our customers, and we're doing it. And there's example-after-example across the company of how our teammates are working together on behalf of the customer.

I'll just tell you my experience because I'll tell you, 10, 15 years ago, we were organized by business. And I'll tell you, we had some internal tension between, is this my customer or that customer? And right now, I get surprised by what our commercial teams are doing across the enterprise of working with our customers on behalf of the customer.

And so we are able to integrate our offerings, whether it's consumer or corrugated machinery. We have some nice digital capabilities, and that's working to our benefit, and it's showing up in the results this quarter. Now I'm going to stop, and I think Jeff's led a lot of this activity. I'd just invite Jeff to add anything to that.

[Jeff Chalovich]

I think, Steve, you covered it well. We continued to see success in the packaging spaces, combining our businesses, and that's with innovation and our machinery. I'll give one good example of the enterprise. In the last quarter, we've had a large oatmeal producer. So the packet of oatmeal is from paper from our Longview mill to a customer.

We have a -- the 40 carton box that it goes in as ours and the corrugated wrap that goes around. So I'm not -- so that's a 5-year deal set with machinery and all of our products that we make. And it probably is over $40 million roughly in the 5 years for us. So I think to Steve's point, if you highlight the packaging, we have a strong platform, and we'll continue to grow in both.

[Operator]

That's all the time we have for questions today. It is now my pleasure to turn it back over to the WestRock team for final remarks.

[Steve Voorhees, CEO, President & Director]

Okay. Yes. I'll just make -- George and Mark talked about Jim Porter and Jim Porter is retiring. And he's just had a very accomplished career, and he's been an amazing friend, an amazing partner, and he's brought passion to what he does. And it's just been an incredible contributor to the management team.

And I am excited that he's staying with us as an adviser to the company and staying involved with Gondi, and he's a friend that will be available by phone. So I look forward to phoning a friend when we have issues to go forward. So I appreciate the questions, people, and engagement on the call and we look forward to our next call. And I guess, it will be in January. Okay. So thanks, everybody.

[Ward Dickson, Executive VP & CFO]

Thank you.

[Operator]

This concludes today's call. We thank you for your participation. You may now disconnect.