International Paper (IP) Poised For Growth Despite Risks

On May 15, we issued an updated research report on paper and packaging firm International Paper Company (NYSE:IP) .

Headquartered in Memphis, TN, International Paper is a global paper and packaging firm with operations in North America, Europe, Latin America, Russia, Asia, and North Africa. The company employs approximately 55,000 people and is strategically located in more than 24 countries serving customers worldwide.

International Paper is undergoing restructuring initiatives to transform itself into a core packaging company. The company intends to invest $300 million in 2016 and 2017 to further 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%. Moving forward, International Paper intends to focus more resources on high-return capital projects within its core businesses that can drive additional earnings growth. The company has outperformed the Zacks categorized Paper & Paper Products industry last month with an average return of 3.6% compared with a 2.7% gain for the latter.

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 over time across the business. International Paper has completed the acquisition of leading timberland owner, Weyerhaeuser Co.’s pulp business for $2.2 billion in cash. With a combined capacity of nearly 1.9 million metric tons of pulp, the transaction is likely to strengthen International Paper’s position in the global fluff pulp market and augment its operating cash flow. In addition, the company expects the acquisition 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.

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, including caustic soda and starch, and energy sources, principally natural gas, coal and fuel oil. Rising energy, chemical and OCC costs remain headwinds, particularly under harsh winter conditions. This is likely to affect its profitability to some extent.

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 changes in the number of retirees are likely to increase pension costs and reduce its cash flow, thereby limiting the positives from its acquisition binge, a primary growth driver.

Nevertheless, we remain impressed with the inherent growth potential of this Zacks Rank #3 (Hold) stock. Some better-ranked stocks in the industry include Mercer International Inc. (NASDAQ:MERC) , Sappi Limited (OTC:SPPJY) and Stora Enso Oyj (OTC:SEOAY) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Mercer is currently trading at a forward P/E of 7.15x.

Sappi has a long-term earnings growth expectation of 3.7%.

Stora Enso has a long-term earnings growth expectation of 3.0%.

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