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International Paper Focuses on Core Businesses, Risks Remain

Zacks

On Oct 9, we issued an updated research report on paper and packaging firm, International Paper Company IP.

Growth Drivers

International Paper is undergoing restructuring initiatives to transform itself into a core packaging company. The company intends to invest $300 million through 2017 to improve its North American containerboard mill system, enhance product quality, and reduce manufacturing and delivery costs. These projects are expected to have a collective internal rate of return of 20%.

At the same time, International Paper is divesting its non-core businesses to focus more resources on high-return capital projects in its core businesses that can drive additional earnings growth. The company’s strategic move is aimed to improve its long-term profitability as it faces stiff competition from diverse players across the industry.

International Paper recently completed the divesture of its foodservice business in China. The assets were sold to Huhtamaki Hong Kong Limited, one of the world’s largest packaging companies with 68 manufacturing units and 23 sales offices in 34 countries, for an undisclosed amount. The divested asset portfolio included two manufacturing plants with employee strength of roughly 200.

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 business, which continues to generate the best margins in the industry. The company is taking initiatives to drive further margin expansion across the business through inorganic growth. The acquisition of Weyerhaeuser Co.’s pulp business has strengthened its position in the global fluff pulp market and augmented its operating cash flow. With a combined capacity of nearly 1.9 million metric tons of pulp, the acquisition is likely to generate annual synergies of approximately $175 million by the end of 2018 along with a higher flexibility to manage a wide portfolio of products to meet customer needs through superior R&D capabilities and priceless patent portfolio.

Headwinds

However, 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 like caustic soda and starch, and energy sources, principally natural gas, coal and fuel oil. Rising energy, chemical and OCC costs remain headwinds, particularly in harsh winter conditions. This is likely to affect its profitability to some extent. The company has underperformed the industry with an average year-to-date return of 8.3% compared with an 11.6% gain for the latter.


In addition, International Paper has huge pension obligations for substantially all U.S. salaried employees hired prior to Jul 1, 2004 and largely all hourly and union employees regardless of the hire date. Pension plan assets are primarily made up of equity and fixed income investments. Fluctuations in actual equity market returns, changes in general interest rates and in the number of retirees are likely to increase pension costs and reduce its cash flow, thereby limiting the positives from its acquisition spree, a primary growth driver.

Zacks Rank & Key Picks

Nevertheless, we remain impressed with the inherent growth potential of this Zacks Rank #3 (Hold) stock. Better-ranked stocks in the industry include Fibria Celulose S.A. FBR, Veritiv Corporation VRTV and Stora Enso Oyj SEOAY, each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Fibria Celulose has a long-term earnings growth expectation of 19.4%.

Veritiv has a long-term earnings growth expectation of 21.9%.

Stora Enso has a long-term earnings growth expectation of 9%.

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