We have recently downgraded our recommendation on
International Paper Co.
) from Outperform to Neutral based on pension headwinds,
increased raw material costs and high debt levels. Currently, the
stock retains a Zacks #3 Rank, implying a short-term Hold
Mergers and acquisitions remain International Paper's key
strategy to strengthen its businesses over the long term. The
acquisition of Texas-based Temple-Inland is the largest since it
acquired Weyerhaeuser Co.'s (WY) corrugated-packaging business
for $6 billion in August 2008. The company has achieved its
initial $300 million synergy target a year ahead of schedule, and
expects an additional $100 million before the integration is
complete. The transaction is expected to be accretive to EPS
within one year of closing and incrementally beyond 2013.
Moreover, the combination will strengthen the packaging business
of North America by increasing its share in the corrugated
packaging market to 34% from the current level of 27%.
International Paper has several ongoing strategic and
cost-saving projects and initiatives in Russia, China and Brazil.
The International Paper-Ilim joint venture in Russia is working
on two major projects - a pulp mill in Bratska and a new paper
machine at Koryazhma mill in Russia. These represent a combined
investment of $1 billion and International Paper expects to
generate over 20% in returns. In China, the International Paper-
Sun joint venture has set up a new consumer paperboard line. The
company is targeting more than 12% return on the $330 million
The company has recently entered into a joint venture with
Grupo Orsa, a leading corrugated packaging producer in Brazil and
signed a supply agreement with Fibria to extend the option to
build a second uncoated freesheet machine at its Tres Lagoas mill
between 2016 and 2018, in order to meet the increase in demand.
Going forward, these initiatives will contribute to both earnings
and cash flow immensely.
International Paper is working toward transforming and
improving the profitability of its distribution business, Xpedx.
Improvements are expected in procurement, replenishment of
orders, reduced stock keeping units (SKU) and supply chain
(including fewer/larger warehouses). We believe that these
initiatives will boost results and be accretive to EPS going
International Paper recently hiked its annual dividend by 14%
to $1.20 per share from the previous payout of $1.05.
International Paper had earlier hiked its dividend by 40% to
$1.05 per share in March last year from the previous dividend
payout of 75 cents.
Through two dividend hikes, in April 2010 and subsequently in
January 2011, the company substantially raised its dividend
payout from 10 cents to 75 cents - a positive development for the
shareholders, since the company had slashed its dividend by 90%
to 10 cents in March 2009, in order to preserve cash to counter
the economic downturn.
International Paper has more than doubled its free cash flow
from the 2000-2004 levels. We expect International Paper to
continue to utilize its sound cash flow by investing in capital
projects, pursuing accretive acquisitions, reducing its total
debt and returning a greater proportion of cash to shareholders
through increased dividend.
On the flipside, rising energy, chemical and old corrugated
containers costs remain headwinds. Further, margins in the fourth
quarter will be affected by the startup costs from the
aforementioned investments in Ilim and Sun projects, higher
interest expense related to the debt issued for Temple Inland
acquisition and increase in maintenance expense and higher
pension expense. For 2013, management expects pension expense to
increase by $250-300 million in 2013.
Even though International Paper is making efforts to repay its
debts, its debt levels still remain high. It was further
aggravated by the issue of debt to fund the Temple Inland
acquisition. The debt-to-capitalization ratio remains high at
59.9% as of September 30, 2012.
Memphis, Tennessee-based International Paper is a global paper
and packaging company with operations in North America, Europe,
Latin America, Russia, Asia and North Africa. International Paper
conducts its businesses through five segments: Printing Papers,
Industrial Packaging, Consumer Packaging, Distribution (Xpedx)
and Forest Products. International Paper competes with
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