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Alan Ibrahim

IP AT A GLANCE

P/E ► -7.58   EV/EBITDA ► 18.9 VERY HIGH ROA ► -2.1% AVG ROE ► -17.4% AVG Debt to Equity ► 4.50 AVG Current Ratio ► 1.91 AVG Interest Coverage Ratio ► 0.0300 AVG

 

 

 

 

 

 

International Paper Company (NYSE: IP) makes paper and packaging products. The company's top paper brand is Hammermill, and printing paper represented 45% of the company's 2007 operating income.^[1] 78% of of net sales in 2007 came within the United States. ^[2]

In July 2005, the company consolidated its operations to focus on three platform businesses: Uncoated Papers, Industrial Packaging, and Consumer Packaging ^[3]. The Uncoated Papers business handles the production of printing and writing paper, while the Industrial Packaging business produces containerboard used to make boxes, and the Consumer Packaging business produces cardboard used in the packaging of consumer goods ranging from food to cosmetics. The company sold its entire forest products segment in 2006 (this segment represented 11% of net sales in 2005^[4]).

In 2008, IP is being tested by increasing energy and commodities prices, which are hiking up the cost of obtaining raw materials and making packaging products. International Paper is dependent on obtaining materials such as wood fiber, caustic soda, and polyethylene^[5] at low prices to reduce costs. The price of caustic soda rose $75/ton at the end of 2007,^[6] and the rising costs of these commodities are forcing the company into a difficult choice - raise prices on its products and risk losing customers, or cut its operating margins and earn less profit (operating margins fell from 14.5% in 2006 to 7.6% in 2007).^[7]

Business Overview

Product Segments

International Paper divides its sales into six different product segments

Printing Papers (29% of net sales, 45% of operating profit)

The company is one of the world’s leading producers of printing and writing paper. 2007 Net sales of the Printing Paper segment were down 3% compared to sales in 2006; however, operating profits were up 73% compared to the previous year as a result of higher prices in North America and Brazil and improved manufacturing operations. ^[1]

• Uncoated Papers: this type of paper is used in copiers and printers and can be transformed into brochures, pamphlets, cards, and books. The company sells this kind of paper under brand names such as Hammermill, Springhill, Williamsburg, and Postmark.

• Market Pulp: is used to make printing, writing, and specialty paper as well as towel, tissue, and filtration products.

Industrial Packaging (23% of net sales, 21% of operating profit)

The company is the third largest manufacturer of containerboard in the United States as it produces 4.8 million tons annually. About 70% of the containerboard is converted into corrugated boxes (heavy cardboard) and other types of packaging^[8]. In 2007, net sales in the Industrial Packaging segment were up 6% compared to sales in 2006. Operating profits were also 26% higher compared to the previous year. This increase in sales was due mostly to improved pricing but was offset by higher raw materials and freight costs^[9].

International Paper Net Sales By Segment^[10]

Consumer Packaging (13% of net sales, 8% of operating profit)

High quality coated paperboard under the brands Everest, Fortress, and Starcote is used in packaging everyday products such as food, cosmetics, and pharmaceuticals. The paperboard is also sold in commercial printing for cards, books, and lottery tickets under the brand Carolina. In 2007, net sales of the segment increased 12% and operating profits increased 15% compared to 2006. Increase in sales due to higher prices and a higher sales volume were offset by increasing raw material and energy costs ^[11].

Distribution (32% of net sales, 6% of operating profit)

The company’s North American merchant distribution business xpedx provides distribution services and products to markets such as commercial printers, building services, and manufacturers. The business operates out of 125 warehouse locations and 148 retail stores in the U.S., Canada, and Mexico. The segment’s 2007 net sales were up 8% and operating profits up 14% compared to 2006 ^[12].

Forest Products (2% of net sales, 19% of operating profit)

As part of the company’s transformation plan, the company sold 5.6 million acres of forestland in 2006^[13] . At the end of 2007, the company owned approximately 300,000 acres of forestland in the United States. The remaining forestland is managed as a portfolio to maximize monetary value to shareholders ^[1].

Specialty Businesses and Other (1% of net sales, <1% of operating profit)

This segment previously included the Arizona Chemical business, which was sold in the first quarter of 2007^[14][15].

International Paper Net Sales by Region^[2]

International Paper’s Transformation Plan

On July 19, 2005, International Paper announced that it would be establishing a three-part business transformation plan to improve returns, strengthen the balance sheet, and return cash to shareholders. The main strategy of the plan was to consolidate business and focus on two key platform businesses: uncoated papers and industrial and consumer packaging (which includes the distribution business xpedx). The company felt that it had a solid global foundation in the uncoated paper market, as it was the world leader in uncoated paper production at 6.6 million tons annually, and saw opportunities for growth in packaging. In 2004, these businesses accounted for more than 70% of the company’s net sales. Another part of the plan dealt with profit improvements, which included resizing to a smaller asset base, using a more profitable mix, and implementing a U.S. mill realignment to cut costs ^[16].

In accordance to the transformation plan, the company has already divested away from several of its businesses. In 2006, the company sold 5.6 million acres of forestland, virtually selling off its Forest Products segment. In 2007, the company completed the sales of its Beverage Packing operations^[17], its Kraft Papers business ^[18], its Arizona Chemical business, and most of its remaining Wood Products segment. These sales of businesses were in line for the consolidation and cost cutting measures the company had planned to do.

In 2008, the company switched rolls as it went from major seller to a major buyer. In March, the company purchased the containerboard, packaging, and recycling operations of Weyerhaeuser Company (WY), one of its biggest competitors^[19]. This purchase lies directly in line with the company’s goal to expand its industrial and consumer packaging divisions. The purchase included 9 containerboard mills and 72 packaging factories, all of which will be extremely helpful to the two packaging divisions.

Financial Metrics

In 2007, International Paper saw a third straight year of positive gains. Net sales declined -0.5% from $22 billion to $21.9 billion but net income rose 11.2% from $1.05 billion to $1.17 billion ^[20]. A decrease in net sales is a result of higher raw materials and energy costs. Higher earnings can be attributed to the cost cutting measures of the transformation plan.

International Paper Net Sales & Net Income^[21]

Trends and Forces

Rising Commodities and Energy Prices are Forcing International Paper to Make Difficult Choices

Higher production costs due to high raw materials and energy costs have already forced the company to shut down several of its facilities, such as its beverage packing operations and Arizona Chemical plant. The ability to obtain raw materials such as wood fiber, caustic soda, and polyethylene ^[5]at favorable prices is an essential part of the company’s success. Higher commodities prices translate into high production costs for the company, which forces the company to either raise the prices of its products by placing the burden on the consumer or to take the burden itself by absorbing the higher costs and decreasing profit margins. For example, in 2008 the company faces higher wood fiber costs, a material the company's corrugated containers are based. Prices and demand for these materials have reached record demand, growing at 8-10% annually, and price ^[22][23]. In addition, price for caustic soda, an essential chemical that is used in the company’s manufacturing processes, saw prices jump $75/ton at the end of 2007 and in the beginning of 2008 ^[6].

The company also faces problems as the increasing price of energy adds to production costs. Production plants and its machines are powered by oil and natural gas^[24], both of which are seeing record prices ^[25]. Higher energy costs translates into higher production costs and once again the company is forced to either pass the burden to consumers by raising prices or take the burden itself and suffer decreasing profit margins. Despite increasing prices on most of its products the company still suffered an extreme margin drop of 50% from 2006 to 2007^[7]; however, the company posted a higher net income in 2007 because in 2006, the company endured substantial expenses and taxes relating to its divested assets, which cut away from profits.

Environmental Regulations and Liabilities

In 2007, the company spent $10 million on direct environmental costs ^[26] and $59 million on projects with aims to control pollution releases into the air and water ^[27]. International Paper is forced to adhere to many federal, state, provincial, foreign, and local environmental regulations. To make sure that these regulations aren’t violated, the company must implement policies and invest in more efficient technology to ensure they are emitting below pollution emission standards; this process can be very costly to the company. In addition, if the company fails to meet all environmental regulations, they face hefty fines. Such examples of environmental regulations are the EPA’s Cluster Rule ^[28] for water discharges and its Maximum Achievable Control Technology (MACT)^[29] standards.

A Slowing Economy Means Less Demand for International Paper’s Products

International Paper is dependent on consumers and businesses buying typical goods, especially durable goods. A slowing economy spells trouble for International Paper. As consumers cut back on spending ^[30], it leads to a decrease in demand of goods. As the demand for these goods drops, International Paper’s customers order less corrugated containers because fewer items are being shipped out. Fewer sales lead to less revenue and more struggles for the company. For example, because American consumers are spending less money and are less willing to get car repairs due to the slumping economy ^[31], fewer automotive parts are being ordered by repair shops. Fewer parts means a decrease in demand for IP's corrugated packaging.

Can International Paper Replace the Revenues of its Divested Assets?

When International Paper decided to focus its business on uncoated paper and industrial and consumer packaging and to divest from its other segments, the company took a substantial risk in concluding that it would be able to replace the revenue generated by the divisions and eventually profit from the divestiture of these assets. Although the company is cutting operation costs and saving some money, most of the risk lies in the company’s ability to recapture the $3.49 billion annual revenue^[4] that its departed divisions contributed to the balance sheet. This means that the company will have to either produce and sell more of its current products or spend money on R&D to create new and profitable items.

Electronics Decreasing Global Paper Demand?

A good chunk of International Paper’s revenue comes from the sale of ordinary printing and writing paper. But as the world becomes friendlier to technological change, the global demand for paper has taken a slight hit. Paper consumption per person grew annually in the 1980's and 90's, but has plateaued and fallen in the 2000's; consumption per person in the world's richest countries fell by 6% from 2000 to 2005. ^[32] For International Paper, this simply means that there is less revenue to earn in the paper market. The United States is already seeing some affects of this technological switch-over. Major newspapers such as the Chicago Tribune and L.A. Times are cutting hundreds of staff positions because they simply can’t afford to pay their employees with the declining demand for paper newspapers ^[33]. The United Postal service has continually increased the price of sending first-class mail as a result of steady quarterly losses^[34]. Although the demand for paper is still very high and the average person still consumes more than 500 pounds of paper annually, ^[32] people are starting to make the switch-over to electronics which is starting to bring those consumption numbers down; in a shrinking paper market, International Paper has less opportunity for growth.

Competitors

Because the Paper & Paper Products Industry has few barriers to entry and many competitors, the company faces competition from both big companies with a diversified line of products and other smaller narrowly-focused companies.

The company’s paper making competitors are:

Domtar (UFS) - Domater is the largest (by production capacity) maker of uncoated freesheet paper in North America and the second largest in the world; making it IP's top competitor in the business. 82% of Domtar's revenue came from its paper segment, while the rest came from its other papergrade, fluff, and specialty pulp business^[35].

Wausau-Mosinee Paper (WPP) - Wausau Paper focuses on making specialty paper products but also prdocues printing and writing paper. 40% of the paper the company produced was colored paper, which adds a unique touch to the company's products^[36].

The company’s paper-based packaging competitors are:

Packaging Corporation of America (PKG) - PKG is the sixth largest producer of containerboard and corrugated products in the United States. It's only business segment is focused on the production of containerboard and corrugated materials, which makes it a direct competitor of International Paper in this business^[39].

Sonoco Products Company (SON) - Sonoco generates 78% of its revenue from it's consumer packaging and tubes and cores/paper segments^[40]. Although the company doesn't produce containerboard and corrugated packaging like IP does, its paperboard products are used for packaging. Also, unlike Smurfit-Stone, Sonoco has a packaging services segment; this segment represented 13% of the Sonoco's revenue in 2007^[41].

Smurfit-Stone Container (SSCC) - Smurfit-Stone makes paper based packaging products with a focus on containerboard and corrugated containers^[42].

Rock-Tenn Company (RKT) - Rock-Tenn provides many different types of packaging material such as paperboard, corugated packaging, folding cartons, and interior packaging ^[43].

References

1. ↑ ^{1.0 1.1 1.2} IP 2007 Annual Report pg. 24
2. ↑ ^{2.0 2.1} IP 2007 Annual Report pg. 44
3. ↑ InTech “International Paper Looks to Jettison Assets” 27 July 2005
4. ↑ ^{4.0 4.1} IP 2005 Annual Report pg. 36
5. ↑ ^{5.0 5.1} IP 2007 Annual Report pg. 5
6. ↑ ^{6.0 6.1} Purchasing.com “Caustic soda prices up on tight supply…” 13 March 2008
7. ↑ ^{7.0 7.1} Google Finance: IP Financial Statements
8. ↑ IP 2007 Annual Report pg. 23
9. ↑ IP 2007 Annual Report pg. 26
10. ↑ IP 2007 Annual Report pg. 43
11. ↑ IP 2007 Annual Report pg. 27
12. ↑ IP 2007 Annual Report pg. 28
13. ↑ New York Times "International Paper to Sell Most of Its Forestland" 5 April 2006
14. ↑ IP 2007 Annual Report pg. 29
15. ↑ Memphis Business Journal "IP Completes Sale of Arizona Chemical" 28 Feb 2007
16. ↑ Press Release “International Paper Announces Plan to Transform Its Business Portfolio and Performance” 19 July 2005
17. ↑ International Herald Tribune “International Paper to Sell Beverage Packing Division, U.S. Paper Mill to New Zealand Company” 13 Oct 2006
18. ↑ Goliath “International Paper to Sell Kraft Papers Business” 1 Aug 2006
19. ↑ International Herald Tribune “International Paper Buys Weyerhaeuser Unites” 17 March 2008
20. ↑ ^{20.0 20.1 20.2} IP 2007 Annual Report pg. 14
21. ↑ IP 2007 Annual Report pg. 10
22. ↑ World Resources Institute "Summary: Wood Fiber Consumption and the World’s Forests"
23. ↑ International Business Times "Recovered Paper Prices Expected to Hit Record High" 18 June 2008
24. ↑ Yahoo! Finance “Sector Snap: Paper Product Makers Set for Rally?” 18 July 2008
25. ↑ CNN Money “Oil Hits $140 for the First Time” 26 June 2008
26. ↑ IP 2007 Annual Report pg. 11
27. ↑ IP 2007 Annual Report pg. 39
28. ↑ EPA “EPA’s Final Pulp, Paper, and Paperboard “Cluster Rule” – Overview”
29. ↑ Ohio EPA “Maximum Achievable Control Technology (MACT) Standards”
30. ↑ New York Times “Americans Cut Back Sharply on Spending” 14 Jan 2008
31. ↑ Morningstar "Auto Parts, Service Industry Hit As Americans Drive Less" 24 July 2008
32. ↑ ^{32.0 32.1} New York Times "Pushing Paper Out the Door" 10 Feb 2008
33. ↑ New York Times “More Staff Cuts Expected at Chicago Tribune and Los Angeles Times” 23 April 2007
34. ↑ Market Watch “U.S. first-class-mail rate to rise 1 cent to 42 cents” 11 May 2008
35. ↑ UFS 2007 Annual Report pg. 4
36. ↑ WPP 2007 Annual Report pg. 2
37. ↑ Google Finance: UFS
38. ↑ Google Finance: WPP
39. ↑ PKG 2007 Annual Report pg. 3
40. ↑ SON 2007 Annual Report pg. 17
41. ↑ SON 2007 Annual Report pg. 5
42. ↑ SSCC 2007 Annual Report pg. 2
43. ↑ RKT 2007 Annual Report pg. 3-4
44. ↑ Google Finance: SON
45. ↑ Google Finance: PKG
46. ↑ Google Finance: RKT
47. ↑ Google Finance: SSCC