We have recently upgraded International Paper (IP - Analyst Report) from Neutral to Outperform encouraged by its merger and acquisition strategy, particularly the merger with Temple-Inland and its acquisition of a majority stake in Andhra Pradesh Paper Mills. The latter will help the company capitalize on the burgeoning demand for paper and packaging products in India. Furthermore, through its joint ventures, International Paper has significant projects underway in Russia and China. All these will help the company sustain its earnings growth.
The Texas-based Temple-Inland acquisition has been recently finalized. The takeover will be International Paper’s largest since its August 2008 acquisition of Weyerhaeuser Co.’s corrugated-packaging business for $6 billion. The combination would increase International Paper’s share of the North American corrugated-packaging market to about 40% from the current 27%. The acquisition is expected to augment the bottom line in the very first year and yield synergies of $300 million annually within two years of closing, derived largely from operations, freight, logistics, selling expense and overheads.
International Paper also completed the acquisition of a majority stake in leading Indian paper company Andhra Pradesh Paper Mills Limited. This transaction made International Paper the first global paper and packaging company to have a significant presence in India’s growing paper and packaging industries.
Furthermore, the International Paper Ilim joint venture in Russia has been growing rapidly; International Paper’s initial investment in Ilim was $600 million. International Paper has received $234 million in dividends, recovering about 39% of the investment. The Ilim joint venture is working on two major projects which should be complete by 2012 end. A pulp mill is being modernized, upgraded and expanded in Bratsk, which will be the closest and lowest-delivered-cost softwood pulp mill to China. A new paper machine at Koriatza mill in Russia will be added as the Russian market is growing at about 6% a year. These represent a combined $1 billion of investment and International Paper is expecting over 20% returns.
In China, the International Paper-Sun joint venture is building a new consumer paperboard line that should come online late in 2012. These initiatives will contribute to both earnings and cash flow substantially, going forward.
International Paper hiked the quarterly dividend on its common stock thrice in the past one year. This is definitely a positive signal for its shareholders, since the company had slashed its dividend by 90% to $0.10 in March 2009 in an effort to preserve cash during the economic downturn. International Paper has more than doubled its free cash flow compared to the 2000-2004 period. We expect International Paper to continue utilizing its sound cash flow by investing in capital projects, indulging in acquisitions, reducing its total debt and returning a greater proportion of cash to shareholders via incremental dividends.
On the flipside, International Paper’s debt levels remain high. As of September 30, 2011, International Paper’s total debt was $7.8 billion with a debt-to-capitalization ratio of 53.3%. Further, to fund the Temple-Inland acquisition, International Paper has priced a sale of $1.5 billion in debt. International Paper will sell $900 million in senior notes due 2022 and $600 million in senior notes due 2041.
International Paper’s acquisition of Temple-Inland has not yet been approved by the Department of Justice. Even if the merger goes through, given the magnitude, integration risks are high. Besides, International Paper has yet to prove its ability in realizing synergies from the acquisition. Any misstep can weigh on the company’s earnings.
The company depends heavily on raw materials such as wood fiber, purchased in the form of pulpwood, wood chips and old corrugated containers (OCC), and certain chemicals, including caustic soda and starch, and energy sources, principally natural gas, coal and fuel oil. Though OCC costs have moderated lately, rising chemical and energy costs can play spoilsport.
On the whole, considering the overwhelming positives, we upgrade our recommendation from Neutral to Outperform on International Paper. The quantitative Zacks #2 Rank (short-term Buy rating) for the company indicates upward pressure on the stock over the near term.
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 MeadWestvaco Corporation and Weyerhaeuser Co. (WY - Analyst Report).