International Paper Restructures Portfolio, Risks Remain

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

Growth Drivers

International Paper aims to undergo restructuring initiatives to transform itself into a core packaging company. The company intends to invest considerably 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%.

Mergers and acquisitions also 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. It is further taking initiatives to drive margin expansion across the business through inorganic growth.

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 has strategically offloaded businesses in China to focus more on its U.S. operations. It believes that it could cater to the Chinese and Asian markets more effectively by supplying globally competitive products primarily through its Ilim joint venture in Russia and through exports from the United States and other parts of the world.

International Paper recently completed the divesture of its consumer packaging business in North America. The assets were sold to Graphic Packaging Holding Company (NYSE:GPK) , a leading provider of paper-based packaging solutions for food, beverage and other consumer product companies. The divested asset portfolio included two manufacturing plants and four converting facilities with employee strength of roughly 3,900.

Graphic Packaging will own 79.5% of the combined company while International Paper will have ownership of the remainder. The transaction would help Graphic Packaging extend its business in the foodservice and folding carton markets. Also, the divesture helped International Paper to focus on its core businesses and strengthen its balance sheet as Graphic Packaging assumed $660 million of its debt.

Headwinds

With continued portfolio restructuring activities, the paper and packaging products manufacturer aims to improve its long-term profitability as it faces stiff competition from diverse players across the industry.

The company depends heavily on raw materials such as wood fiber, purchased in the form of pulpwood, wood chips and old corrugated containers (OCC), certain chemicals like caustic soda and starch, and energy sources like 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.

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.

International Paper has underperformed the industry in the last three months with an average return of 7.9% compared with 10% gain for the latter.

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 Domtar Corporation (TO:UFS) and Neenah, Inc. (NYSE:NP) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Domtar has a long-term earnings growth expectation of 5%. It has beaten earnings estimates thrice in the trailing four quarters with an average positive earnings surprise of 21%.

Neenah has a long-term earnings growth expectation of 5%. It has beaten earnings estimates in each of the trailing four quarters with an average positive earnings surprise of 11.6%.

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