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International Paper's Segments Poised for Growth, Costs Rise

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On Nov 23, we issued an updated research report on International Paper Company (IP - Free Report) . Driven by solid commercial performance and continued healthy demand across its businesses, the company is well poised to deliver improved results in the fourth quarter of 2018 and fiscal 2019 as well.  However, elevated input costs and distribution costs will dent near-term margins.
 
Segments Poised for Growth
 
International Paper's North American Industrial Packaging business (that generated 69% of third-quarter 2018 revenues) has consistently outperformed industry shipments in the first three quarters of 2018. The company is witnessing strong demand across all channels and realized about 90% of its recent box price increase in the third quarter. The last part of the recent price increase will be realized in the fourth quarter. Further, the company’s focus to serve the rapidly-growing segments has been an important contributor to the strong performance. International Paper is leading in e-commerce, fresh produce and protein. In the European packaging business, the Madrid mill has commenced operations. Once it ramps up, it will materially enhance the company’s margins, cost position and its product range.
 
In the Global Cellulose Fibers business, the company delivered record fluff pulp shipments during the third quarter, despite the impact of Hurricane Florence. Global pulp demand remains strong and demand in the fluff segment continues to grow 4-5% annually. New product introductions in the fluff pulp segment and the company’s optimization initiatives are likely to drive results. In the Printing Papers segment, improved global demand will bolster segment revenues. Backed by healthy demand and focus on commercial excellence, the company is poised to deliver improved results in the fourth quarter of 2018 and 2019 as well.
 
Leaner Portfolio to Aid Results
 
International Paper is undergoing restructuring initiatives to transform itself into a core packaging company. The company has strategically offloaded businesses in China to focus more on its U.S. operations. It believes that it could cater to the Chinese and Asian markets more effectively by supplying globally competitive products primarily through its Ilim joint venture in Russia, and exports from the United States and other parts of the world.
 
The company also completed the divesture of its consumer packaging business in North America to Graphic Packaging Holding Company (GPK - Free Report) . The divesture helped the company to focus on its core businesses and strengthen its balance sheet as Graphic Packaging assumed $660 million of its debt. The company intends to invest significantly to improve its North American containerboard mill system, enhance product quality, and reduce manufacturing and delivery costs. International Paper has decided to explore strategic alternatives for its Brazilian packaging operation, which has fallen below expectations for the past several years.
 
Mergers & Acquisitions: A Key Catalyst
 
Mergers and acquisitions remain a key strategy for International Paper to strengthen its long-term business proposition. In North America, the company envisions a large opportunity within its industrial packaging businesses, which continue to generate the best margins in the industry. The company is taking initiatives to drive margin expansion over time across the business further. International Paper’s acquisition of leading timberland owner Weyerhaeuser Company’s (WY - Free Report) pulp business has strengthened its position in the global fluff pulp market. The company expects the buyout to generate annual synergies of approximately $175 million by the end of 2018. It will also provide the company with higher flexibility in managing a wide portfolio of products to meet customer needs through superior R&D capabilities and priceless patent portfolio.
 
Primary Headwinds
 
Hurricane Florence had a negative impact of $36 million on International Paper’s third-quarter results, which included $8 million in volume and $28 million in operations. Notably, three mills and three box plants were impacted. The company expects an impact of $15 million in the fourth quarter, mostly in the Global Cellulose Fibers business.
 
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.  Elevated input costs (fiber, chemicals, energy, and freight) will constrict margins in the near term. Further, distribution costs are trending upwards lately due to a very tight truck and rail availability as well as higher diesel fuel cost. This will affect the company’s margins in the near term. Further, International Paper is set to incur elevated operational costs in the Printing Papers, primarily owing to unfavorable foreign currency translation. 
 
 
Shares of International Paper have dipped 18.4% in the last year, while the industry’ dipped 11.9%.
 
Zacks Rank & Key Picks
 
Nevertheless, we remain impressed with the inherent growth potential of this Zacks Rank #3 (Hold) stock. A better-ranked stock in the industry is Verso Corporation (VRS - Free Report) , sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
 
The Zacks Consensus Estimate for Verso for the fiscal 2018 is at $3.53, reflecting 571% year-over-year growth. The estimate for fiscal 2019 is at $5.77, reflecting year-over-year growth of 63%. The stock has surged 128% in a year’s time.
 
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