Thursday, October 30, 2008

From The Mailbag: International Paper

International Paper (IP) is a paper and packaging manufacturer and distributor. Its stock price has fallen some 60% since last year, as it has faced tremendous increases in input costs and more recently faces a slowing global economy. Could this represent a value opportunity? There are several things to like about this company's stock price prospects going forward, while there are also some uncertainties.

Over the last several years, this industry has been plagued by overcapacity. Paper mill shutdowns have been the norm for over a decade throughout North America. While IP has fared better than most (thanks to its global diversification: it has production facilities in
North America, Europe, Latin America, Russia, Asia and North Africa) it has been unable to avoid closing mills and reducing assets, thus sustaining declining revenue over the last decade.

While the P/E of 7 and dividend yield of over 6% are appealing, the prevalent overcapacity in this industry makes it difficult to determine if this company's payout is sustainable. While the company does have plenty of liquidity ($4 billion in cash) to meet its obligations for the next couple of years, it has largely financed this cash by increasing its debt level from $6.7 billion to $9.6 billion last quarter, adding to its uncertainty in the longer term.

Furthermore, over the last several years the company has been spending less on capital expenditures than it has been expensing in depreciation, suggesting it is not re-investing to maintain or grow its assets...therefore, the downward trend in revenue should continue going forward (barring blips here and there due to acquisitions).

While the payout may be nice for the next several quarters, unless there is a change in this industry's dynamics (which we don't like to predict as value investors), there could be trouble down the road for this company, particularly considering its current debt to capital ratio of nearly 50%.

For someone who understands the industry well, and can appropriately value IP's assets, this may be a good time to invest. For the rest of us, we may want to save our money for companies that are closer to 'sure things'.

Disclosure: None

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