We maintain our Neutral recommendation on International Paper (IP). The quantitative Zacks #3 Rank (short-term Hold rating) for the company indicates no clear directional pressure on the shares over the near term
While International Paper’s first quarter 2012 earnings per share (EPS) of 57 cents sailed past the Zacks Consensus Estimate, revenues of $6.6 billion failed to meet the concensus.
Mergers and acquisitions continue to be International Paper’s key strategy to strengthen its businesses for the long term. Its acquisition of Texas-based Temple-Inland is its largest since the August 2008 acquisition of Weyerhaeuser Co.’s corrugated-packaging business for $6 billion. The company generated $10 million in synergies in the first partial quarter of ownership. The transaction is expected to be accretive to EPS within one year of closing and incrementally beyond 2013. The combination will fortify the North American packaging business by increasing its share in the corrugated packaging market to 34% from the current 27%.
The company also completed the acquisition of a majority stake in a 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. It is currently 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% in 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 is working towards transforming and improving the profitability of its distribution business, xpedx. Improvements are expected in procurement, replenishment of orders, reduced stock keeping units (SKU), and the supply chain (including fewer/larger warehouses). We believe that these initiatives will boost results and be accretive to EPS going forward.
On the flipside, International Paper’s debt levels remain high, further aggravated by the Temple-Inland acquisition. The debt-to-capitalization ratio increased to 62.2% as of March 31, 2012 from 59.9% as of December 31, 2011.
Given the magnitude of the deal, integration risks continue to be a concern. In addition, International Paper’s failure to realize synergies from the acquisition could negatively impact the company’s earnings. Furthermore, under its consent decree with the Department of Justice, International Paper has to divest 970,000 tons of container board capacity. Even though the company maintains its synergy targets, this has reduced some of the positives from the acquisition and adversely benefited its peers.
Furthermore, rising energy, chemical and OCC costs remain headwinds. Margins will also be affected by the startup costs from the aforementioned investments in Ilim and Sun projects, higher interest expense due to debt issued for Temple-Inland acquisition, increase in maintenance expense, higher pension expense and a higher tax rate.
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 (MWV) and Weyerhaeuser Co. (WY).
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