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Neutral on MeadWestvaco

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We maintain our Neutral recommendation on MeadWestvaco Corporation . The stock presently retains a Zacks #3 Rank (short-term Hold recommendation).

MeadWestvaco’s first quarter adjusted earnings declined 26.5% to 34 cents per share while revenues increased 4% year over year to $1.42 billion. The company did not provide any guidance for 2012. It is hopeful about achieving annual sales growth of more than 5% and earnings growth in the range of 7% to 10% over the next 3 to 5 years. The Zacks Consensus Estimate for the next quarter is pegged at 39 cents and for the year at $1.47.

MeadWestvaco is becoming more of a packaging company moving forward. Following the sale of its Envelope business and the spin-off of the Consumer & Office Products segment, the company now generates 85% of its revenues from packaging. Packaging is a large and growing global market, particularly benefitting from the economic prosperity in emerging markets around the world, particularly in Brazil, China and India, where the rapidly emerging middle classes are triggering dramatic increases in consumer spending.

Furthermore, packaging is critical to the successful marketing of products. Solutions that enhance freshness, convenience, and product safety are becoming imperatives while consumers are more aware. MeadWestvaco is well positioned to capture growth from these trends with its new products and solutions, particularly Captivate, Evertain (its replacement for the composite can), and Polytop's differentiated caps enclosures in the food packaging market. In the beverage market, the company’s new eMerge packaging system is successfully penetrating the rapidly growing multi-pack market in emerging markets.

MeadWestvaco is also expanding its presence in the field of adherence packaging to widen its client base. MeadWestvaco recently introduced Shellpak Renew, its latest design in the Shellpak adherence packaging family. Shellpak Renew helps in making medications easier for patients besides improving their adherence to medications. The company has also acquired AARDEX Group, the leader in measuring patients’ adherence to medications. With this acquisition, the company’s portfolio expanded to offer a complete range of packaging, data analysis and service solution that help in addressing the problem of non-adherence to medications among patients.

MeadWestvaco has stepped up its capital improvement plans and updated its facilities more aggressively. Though this will affect earnings in the short term it should add significantly to the bottom line longer term. The company intends to invest sharply in the range of $650 million to $700 million in fiscal 2012. This would include major profitable growth and productivity investments along with ongoing maintenance and compliance issues. MeadWestvaco has invested around $480 million into the Industrial segment to build a new linerboard machine in Brazil which is nearing completion. It will also invest around $165 million for the construction of a biomass boiler at the Covington facility. The investment in Brazil is expected to boost revenue by 50%  and more than double the operating earnings of the Industrial segment.

We expect MeadWestvaco’s free cash flow to improve significantly, reflecting higher earnings and reduced capital expenditure following the completion of the above mentioned investment in Brazil. Once the new linerboard machine in Brazil comes online and is accretive to earnings, we expect the company to raise its dividend. The company will also utilize its strong cash flow for acquisitions and share buybacks.

On the flip side, we remain concerned about MeadWestvaco’s overt dependence on foreign operations to grow sales. In fiscal 2011, the company derived 34% of total sales from the international business, with 14% generated from Europe and another 2% from export sales to Europe. The persistent debt concerns and soft demand in Europe add to the headwinds.

Second quarter earnings are also estimated to go down from year-ago levels in the wake of higher raw material costs and unfavorable foreign currency translations.

Richmond, Virginia-based MeadWestvaco is a global producer of packaging, coated and specialty papers, consumer and office products, and specialty chemicals. The company operates in 30 countries and serves customers in more than 100 nations. MeadWestvaco’s new organizational structure consists of five segments – Food & Beverage; Home, Health & Beauty; Industrial, Consumer & Office Products; Specialty Chemicals and Community Development; and Land Management. MeadWestvaco competes with International Paper Company (IP - Free Report) and Weyerhaeuser Co. (WY - Free Report) .

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