There's a saying out there (from Warren Buffett, I believe) that goes something like "whenever a great management team and a lousy industry come together, it's the industry that maintains its reputation." That warning would seem to apply to Rock-Tenn (NYSE:RKT) these days as although the company's stock has done reasonably well, management continues to struggle to deliver on the potential synergies and operational improvements at the former Smurfit-Stone assets.

The crux of the Rock-Tenn argument is pretty simple. If Rock-Tenn can do with Smurfit-Stone's corrugated packaging assets what it did previously with its own paperboard/containerboard assets, this will be a large and profitable company. If Rock-Tenn cannot lift up those Smurfit-Stone assets, then the company will languish from a value-destroying deal that levered the balance sheet and saddled it with lesser assets.

Top Investment Trends For 2013: We go over a few investment trends for you to think about for 2013.

Recent Results Show a Lot of Volatility
Rock-Tenn has become an "interesting" stock around earnings time, as investors have run hot and cold on the company's ability to drive better results. In fact, there's been a good quarter/bad quarter pattern ever since the deal for Smurfit-Stone closed that has seen the company swing between beats and misses with little warning.

The issue has been, is and continues to be whether the company can realize the multi-hundred million dollars of potential synergies and cost/margin improvements at Smurfit-Stone. So far, the progress has been disappointing and Rock-Tenn has responded with sweeping management changes at several plants (in addition to ongoing plant closures/consolidations and infrastructure improvements).

This is no trivial question. Not only did Rock-Tenn pay about $3.5 billion for these assets, but corrugated materials now make up about two-thirds of the company's revenue base - making the company's former containerboard operations (which were very well-run) a secondary operation.

SEE: Biggest Merger and Acquisition Disasters

Industry Dynamics Favorable ... for Now
By and large, paper packaging companies are looking at what should be favorable operating conditions. Price hikes in containerboard and cartonboard seem to have stuck, and while fiber prices seem to be moving up a bit, the scale of the increase hasn't been bad. What's more, energy prices are pretty benign, and Rock-Tenn certainly benefits if natural gas prices stay low.

Demand should also be stable to up. Most packaged food companies are seeing volumes stabilize and are allocating more resources to promotional activities. That should help Rock-Tenn's carton and point-of-purchase display business, as well as the corrugated operations. That said, paper packaging producers like International Paper (NYSE:IP), Rock-Tenn and Packaging Corp (NYSE:PKG) generally see their demand tied to economic activity, so there isn't likely to be a huge tailwind for demand. Likewise, Rock-Tenn isn't as leveraged to new product introductions as a smaller company like Graphic Packaging (NYSE:GPK).

I don't think investors can afford to rest completely easy, though. The industry as benefited from a lot of consolidation and capacity curtailment. While the big players have been uncommonly responsible about not bringing mothballed capacity back up at the first sign of better conditions, there is a risk that better industry operating conditions will become a "self-correcting" phenomenon.

SEE: The Industry Handbook

The Bottom Line
An investment in Rock-Tenn comes down to this - do you believe that Rock-Tenn's high-quality management can turn around those Smurfit-Stone assets and make this a much larger very well-run company, or are those Smurfit-Stone assets/operations of a quality such that they cannot be fixed or run well by even a good management team? While I don't mean to give short shrift to matters like input costs, underlying volume growth and so on, I do believe the company's ability to deliver real synergies and margin leverage from Smurfit-Stone is the key question.

Right now I believe that the company will be mostly successful in that regard, but that the Smurfit-Stone assets will never be fully as good as the company's prior containerboard operations. To that end, I see mid-single digit revenue growth and gradual free cash flow margin improvement from the low/mid-single digits into the high single digits over time. That works out to an eye-popping growth rate in the 20% range (off of a low base), but a fair value after debt in the low $80s - making Rock-Tenn a good hold and a potential watch list candidate, but not a very compelling buy today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Markets

    Why Gluten Free Is Now Big Business

    Is it essential to preserving your health, or just another diet fad? Either way, gluten-free foods have become big business.
  3. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  4. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  5. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  6. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  9. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  10. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!