International Paper: Will the Increased Market Share Boost Profitability?

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The world’s largest paper products company, International Paper (NYSE: IP), has taken measures to restructure its operations and add to its market share.  As a result, patient investors have been rewarded nicely, with the stock price currently around $42, a far cry from the 2009 low of $3.93.  However, the market has a lot of questions about the company’s future profitability, mostly as a result of the cyclical and capital-intensive nature of its business. With the company set to report earnings next Tuesday, hopefully investors will get answers.

 

<img src="/media/images/user_14267/ip-chart_large.png" />

 

International Paper has approximately a 30% share of the containerboard market in the U.S. with annual production of about 10 million tons, in addition to its operations in Europe, Asia, and the Middle East.  The company also produces a great deal of writing and printing papers that are used in copiers and to make brochures, pamphlets, and books.  One of the biggest drivers of demand in the coming years should be increasing demand from emerging markets, so pay attention to whatever the company has to say about its international operations. 

As I mentioned previously, the company has taken measures to improve its market share, most notably by acquiring rival Temple-Inland for $4.5 billion in early 2012.  This deal is what made IP the largest producer of linerboard in the U.S. In 2008, IP acquired Weyerhaeuser’s corrugated packaging business, a move that analysts generally consider to be a huge success. 

As IP’s market share increases, it takes advantage of greater economies of scale, which allows the company to operate more efficiently than competitors.  By market cap, IP is several times larger than competitors such as MeadWestvaco Corp (NYSE: MWV), a diversified maker of packaging, and Domtar Corp (NYSE: UFS), which combined the fine paper assets of Weyerhauser with Domtar Inc's, forming the largest US manufacturer of freesheet paper. 

As a result, it has been able to achieve higher margins than these competitors.   Pay attention to the company’s operating margins, which are expected by analysts to narrow to 8.6% for 2012, down from 9.5% previously, better than both of the competitors mentioned. 

MeadWestvaco is expected to have margins of 6.7% for 2012, and Canadian-based Domtar is expected to operate with a 7.7% margin.  For IP, however, the consensus calls for margins to increase into low double-digits in 2013, so the company’s forward outlook could be a telling sign in this respect. 

The other strategic initiative that has been in place is a major restructuring of the company’s operations.  IP decided to concentrate on its core businesses of uncoated paper and packaging products and to divest its other businesses, a move which made the company after-tax proceeds of $11 billion.  Of this sum, $6.2 billion was used to pay down debt, and $1 billion was used to fund the company’s pension obligations, considerably strengthening the balance sheet.  An additional $3 billion was used to repurchase stock, with the rest used for various other investments. 

From a valuation perspective, IP looks pretty attractive right now if the projections of higher margins prove to be accurate.  Currently trading at 16.4 times 2012’s consensus earnings of $2.46, a significant drop from 2011’s earnings of $3.10 per share, IP is expected to grow its earnings nicely over the next few years, mainly due to higher predicted margins that come with the company’s increase in market share. 

Analysts’ consensus call for earnings of $3.61 and $4.37 in 2013 and 2014, respectively, which means year-over-year growth rates of 46.7% and 21.1% are expected. That's an extremely high growth rate for a P/E ratio like IP’s.  To put this growth rate in perspective, IP trades at just 9.6 times 2014’s earnings. 

For this reason, the company’s outlook is more important to shareholders than the 2012 numbers themselves.  The lower earnings are already priced into the stock, and the market is looking to the future.  The market is expecting good things from IP, as evidenced by its valuation (not many companies with earnings that have declined trade at a P/E ratio of 16.4).  If IP is as optimistic as analysts seem to be during its earnings call, it could prove to be a very positive catalyst for the stock indeed.


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