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International Paper Co. (IP - Analyst Report) reported second-quarter 2012 adjusted earnings of 46 cents per share, a 41.8% drop from the prior-year quarter earnings of 79 cents. The results, however, outperformed the Zacks Consensus Estimate of 47 cents.

After including special items, earnings in the quarter stood at 31 cents a share compared with 51 cents in the prior-year quarter.

Net sales rose 6.5% year over year to $7.08 billion, yet missed the Zacks Consensus Estimate of $7.31 billion.

Cost and Margins

Adjusted cost of goods sold amounted to $5.272 billion, a 7.4% increase from $4.907 billion in the year-earlier quarter. Adjusted selling and administrative expenses increased 5.2% to $509 million. Segment operating income decreased 13.4% year over year to $426 million.

Segment Performance

Industrial Packaging: Sales for this segment increased 27.5% year over year to $3.5 billion. Adjusted operating income increased 72.9% to $465 million. The improvement was attributable to synergies from Temple-Inland acquisition, seasonal volume and mix improvement, better operations along with a hike in export prices.

Printing Papers: Sales decreased 5% to $1.51 billion in the quarter. The segment’s adjusted operating income dipped 111% to $105 million. The positive impacts of higher prices in Brazil and Russia along with better price realizations on U.S. exports were partially offset by higher planned maintenance outages.

Consumer Packaging: Sales decreased 21% to $780 million from $945 million in the year-earlier quarter. Adjusted operating profit was $56 million in the quarter versus $164 million in the year-ago quarter. Increase in costs due to escalation in maintenance costs along with weak economic conditions unfavorably affected the segment. However, the Foodservice business performed well, driven by seasonality and product line expansion.  

Xpedx (Distribution Business): Sales for the segment dropped 10.3% to $1.50 billion from $1.66 billion in the year-ago quarter. However, adjusted operating income of this segment increased 171.4% to $38 million.

Financial Position

Cash and cash equivalents were $1.22 billion at the end of the quarter compared with $4 billion at end-2011. Cash flow from operating activities improved to $1.4 billion during the quarter compared with $1.2 billion in the prior-year quarter. Debt-to-capitalization ratio was 62.9% as of June 30, 2012, compared with of 62.2% as of March 31, 2012, and 59.9% as of December 31, 2011.

Our View

Mergers and acquisitions continue to be International Paper’s key strategy to strengthen its businesses for the long term. The company’s acquisition of Temple-Inland is expected to be highly accretive beyond 2013. The combination will fortify the packaging business of North America by increasing its share in the corrugated packaging market to 34% from the current 27%.

However, the debt-to-capitalization ratio remains at high levels.  It was further aggravated by the issue of debt to fund the Temple-Inland acquisition.

International Paper retains a short-term Zacks #3 Rank (Hold). Currently, we have a long-term Neutral recommendation on the stock.

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