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International Paper: Strong Dividends but Weak Balance Sheet

November 23, 2012 | About:
International Paper (IP) a global paper and packaging company with manufacturing operations in North America, Europe, Latin America, Russia, Asia and North Africa. Its businesses include uncoated papers and industrial and consumer packaging, complemented by Xpedx, the company's North American distribution company. Headquartered in Memphis, Tenn., the company employs approximately 70,000 people and is strategically located in more than 24 countries serving customers worldwide. International Paper net sales for 2011 were $26 billion. Temple-Inland Inc., which was acquired in February 2012, had 2011 net sales of $4 billion.

Valuation

IP is currently trading at a trailing twelve months P/E of 19.26 and a trailing twelve months EV/EBITDA of 7.74. IP's current P/E represents a 13% discount to its five year average P/E of 22.1. IP achieved a trailing twelve month ROE of 11.1% and a five year average ROE of 7.7%.

Financial and Business Risks

IP is highly geared with a debt-to-equity ratio of 149% and a net gearing of 131%. This is not helped by an interest coverage ratio of and a quick ratio of 1.2. Also, there is also possibly significant off-balance debt with the 50:50 joint venture with Russia's Ilim. IP is in the process of deleveraging, it has repaid $1.5 billion of balance sheet debt this year.

Changes in the cost and availability of certain raw materials such as virgin wood fiber, recycled fiber, caustic soda and starch, energy sources such as natural gas, coal and fuel oil will impact IP's profitability.

IP's pension plans are currently underfunded and it may be required to make cash payment to the plans over time. The current pension gap is estimated at $2.7 billion.

IP's emerging market operations are effected via joint ventures such as the Ilim joint venture in Russia. Since October 2007, IP and Ilim Holding S.A. have operated a 50:50 joint venture in Russia. IP's share of Ilim’s operating results are reported on a one-quarter lag basis, due to extended time required to prepare consolidated financial information in accordance with GAAP. In the second quarter of 2010, the joint venture initiated a long-term investment program to invest $1.5 billion in Ilim’s three mills over five years.

Business Quality and Capital Allocation

IP is positioned in attractive markets with low-cost assets generating strong free cash flow. 75% of its revenues are generated from North America, where IP is a recognized leader in core segments such as corrugated packaging, uncoated paper, coated paperboard and distribution. Emerging markets contribute the remaining 25% of IP's revenues, where IP has managed to build leading positions in fiber-based packaging and paper segments. IP is the top ranked supplier for corrugated packaging and coated paperboard in North America, and ranked second for uncoated papers. IP is also the market leader for uncoated papers in Brazil and paper, pulp and packaging in Russia.

IP has paid dividends in every single year since 1995 and has a 3.3% dividend yield with a 58% payout ratio. Dividends are paid quarterly. On Oct. 9, 2012, IP announced that its board of directors increased the company's quarterly dividend by 14% to $0.30 per share for the fourth quarter of 2012. IP targets to maintain a sustainable dividend at 30-40% of free cash flow.

In the past six months, eleven insiders have sold 232,002 shares for a total of $8.3 billion.

Conclusion

Valuations are unattractive, with significant on- and off-balance sheet debt weakening the financial position of IP.

Disclosure

The author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


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