Company Description:
International Paper Co. (IP) is a leading global manufacturer of fiber-based packaging and pulp products. IP produces renewable fiber-based packaging and pulp products in North America, Latin America, Europe, and North Africa.
It operates through Industrial Packaging (~84% of 2022 sales) and Global Cellulose Fibers (~16% of 2022 sales) segment. The company’s Industrial Packaging segment manufactures containerboards, including linerboard, medium, white top, recycled linerboard, recycled medium, and saturating kraft. Its Global Cellulose Fibers segment provides fluff, market, and specialty pulps that are used in absorbent hygiene products, such as baby diapers, feminine care, adult incontinence, and other non-woven products; tissue and paper products; and non-absorbent end applications, including textiles, filtration, construction material, paints and coatings applications.
Why IP?
IP’s current Market Cap is about $10.63 billion. (Stock price: $30.62/share as of 5/26/2023)
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IP’s 2019, 2020, 2021, and 2022 FCF were $2,334M, $2,312M, $1,481M, and $1,243M respectively (Source: Yahoo Finance). The 2019-2022 FCF average comes to $1,842M; Keeping it simple, and applying a 10% discount rate into perpetuity would yield the terminal value of IP to be $18.42 billion.
Similarly, IP’s 2019, 2020, 2021, and 2022 Net Income numbers were $1,225M, $482M, $1,752M, $1,504M respectively (Source: Yahoo Finance). The 2020 NI number was depressed due to higher than usual non-operating irregular expense. The 2019-2022 NI average comes to $1,241; Keeping it simple, and applying a 10% discount rate into perpetuity would yield the terminal value of IP to be $12.41 billion. Now, due to the unusual characteristic of 2020, if we were to replace the 2020 NI number with that of 2019, the 2019-2022 NI average would be $1,427. A 10% discount rate on this average would equate to a terminal value of $14.27 billion.
By focusing just on the terminal value and disregarding any future FCF or NI growth, I know that I am not being overly optimistic about the company’s valuation.
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Now, if we were to look at the DCF analysis and take into account growth, then the intrinsic value of the company could reach $24 billion. In my analysis, I am using:
1) 2022 FCF of $1,243M
2) Growth rate of 6% for the first 10 years (in line with ValueLine’s estimated future cash flow growth of 6%)
3) Discount rate of 10%
4) Long Term Growth rate of 3.771% (in line with the US 30-year treasury yield)
5) 349 million shares outstanding
6) Long Term debt of $4,766M
The sum of discounted cash flows for the first 10 years comes to $10.2 billion. The discounted perpetuity cash flow comes to $13.8 billion. By adding these two numbers up, we get the intrinsic value to be $24 billion. If we take into account the long-term debt, then intrinsic value come to $24 – $4.8 = $19.2 billion. At $19.2 billion, the intrinsic value per share equates to $54.96. If we were to disregard the long-term debt, then the intrinsic value per share would come to $68.60.
Filters:
Let’s use Li Lu’s 4 question checklist:
- Is it cheap?
At the current P/E of 7.6, the earnings yield comes to 13.16%. The 10 year median P/E ratio has been 13.3 (earnings yield of 7.51%), so the current stock price is trading at a discount. Comparatively, the S&P 500’s current PE ratio is 22.04 (4.5% yield). So, from an opportunity cost standpoint, IP is attractive. Moreover, IP’s current market cap is below the company valuations that we calculated earlier. In conclusion, IP is cheap. - Is it a good business?
IP’s 10-year average Return on Equity is 23.2%, and the 10-year average Return on Capital is 9.4% (Source: Mergent Report). Additionally, the gross and net margins associated with the business are predictable and have stayed consistent over the past 10 years. IP’s industrial packaging and cellulose fibers business segments, and its products are easy to understand. Lastly, no kind of technological advancement can replace IP’s business. - Who is running it?
Mark S. Sutton is the current CEO of IP. Sutton joined IP in 1984, and has held various positions within the company ranging from Strategic Planning to Supply Chain to holding leadership positions within the Industrial Packaging and Printing Papers segments. 1.85% of the company is held by insiders (Source: Mergent). 90% of the CEO’s pay is based on the company performance (at risk) and 79% of the NEO’s pay is tied to the company performance. The at-risk pay is dependent on performance metrics such as Revenue, Cash Conversion, Adjusted EBITDA, Adjusted ROIC, and Relative TSR. While ideally we would like the compensation not to be tied to “Adjusted” (Non-GAAP) metrics, such compensation metrics seem to be common across the industry. According to Mergent, during Mark Sutton’s tenure, the stock price has appreciated 162%, revenue has grown 348%, and Net Income has grown 1030% (~10x). - What did I miss?
IP spun off its global printing business (now operating as Sylvamo Corp. – SLVM) in October 2021. IP continues to own 19.9% of SLVM’s outstanding shares. This spinoff helped streamline IP’s business, as the management can now focus on its corrugated packaging and absorbent cellulose fibers segments. The spinoff is a also a demonstration of management unlocking shareholder value. It’s noteworthy that in 2022 IP’s net income did not see a huge drop off as the remaining 2 segments had increased sales, which compensated for the sales from the printing business.
Let’s look at Chuck Akre’s 3-legged stool:
- Business
IP has a notable market share in at least 4 industries: Wood Pulp Mills, Paper Mills, Paperboard Mills, and Cardboard Box & Container Manufacturing and Paperboard Mills. The largest market share is in the Wood Pulp Mills industry, where IP accounts for an estimated 31.3% of the total industry revenue; it is also considered a disruptor as their market share has been increasing recently (Source: IBIS World).
IP has predictable and high ROE; 30.1% in 2018, 22.9% in 2019, 15.2% in 2020, 17.9% in 2021, and 16.3% in 2022 (Source: Mergent). The company’s debt to equity ratio is 0.57; on an absolute basis, this goes to show that the company is not overreaching and trying to finance its growth by taking on debt. The company’s inventory turnover has been trending up from 6.9x in 2018 to 7.8x in 2022; this goes to show that the company is getting more efficient at going through its inventory. IP has a current ratio of 1.4, which indicates that the company has enough assets to cover its liabilities over the next 12 months; hence, no immediate liquidity risks. Overall, IP’s balance sheet is strong. In fact, the company’s LT debt and capital lease obligations have decreased from $10B in 2018 to around $4.8B in 2022. The shareholder’s equity has increased from $7.3B in 2018 to $8.5B in 2022. Lastly, the shares outstanding has decreased from 400M in 2018 to 350M in 2022.
The business seems to have a high barrier to entry since capital and equipment play a big role in the manufacturing process. The mills also deal with highly toxic chemicals, which needs specialized machinery. There is growth potential in this area as the industry is focused on improving labor productivity through machines and computers (Source: IBIS World). - Management
TSR is a big component of the management’s compensation. So, the management is incentivized to be shareholder friendly. IP announced its “Building a Better IP” initiative, which is a commitment to deliver $350 and $450 million incremental earnings in 2024 by lowering its cost structure (Source: IBIS World). The “Building a Better IP” program is meant to drive value creation by streamlining and simplifying IP.
IP has consistently paid out dividends, and the management has been buying back shares as the share count has been trending downwards. Lastly, IP’s management is composed of experienced individuals, who are well turned to the industry. - Reinvestment
IP’s Return on Invested Capital (ROIC) was 12.5% in 2018, 8.2% in 2019, 6.4% in 2020, 7.5% in 2021, and 12.5% in 2022 (Source: Mergent). IP’s current WACC is 7.8%, and since the 2022 ROIC is greater than WACC, the management seems to be creating shareholder value. Additionally, in October 2021, the board authorized additional $2 billion stock repurchase program (on top of the remaining $1.3 billion). So, buying the stock back at the current stock price, which has an earnings yield of 13.16%, should be beneficial for the existing shareholders. Lastly, the company is making and benefiting from the investments in capacity in the US box system across the Industrial Packaging business. The company is making investments, which should drive down costs, improve its efficiency, and help increase the overall reinvestment rate.
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Mean Reversion: On the 5 valuation ratios below, we can see that the stock is currently trading below its 5-year averages. There are no significant changes in the industry or the company, so it should be a matter of time before the gap between the ratios are bridged.
Price/Sales: 0.63 (current), 0.83 (5-year average)
Price/Earnings: 7.60 (current), 15.84 (5-year average)
Price/Cash Flow: 6.08 (current), 6.94 (5-year average)
Price/Book: 1.48 (current), 2.25 (5-year average)
Enterprise Value/EBIT: 9.22 (current), 15.36 (5-year average)
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Rule of 72: IP’s ROE is 16.3% and it is likely that IP will be able to sustain this return. So, rule of 72 would dictate that as business owners, we should be able to double our investment in 72/16.3 = 4.4 years.
In conclusion, IP is an undervalued security. An economic slowdown would likely temper the demand; however, IP has survived such macro environments in the past and come out stronger. For example, learning from the pandemic slowdown, IP spun off its paper business and is now more focused as it is streamlining its core business segments.
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Superior North LLC’s content is for educational purposes only. The calculators, videos, recommendations, and general investment ideas are not to be actioned with real money. Vyom Joshi is not a professional money manager or a financial advisor. Contact a professional and certified financial advisor before making any financial decisions. Please review the Disclaimer and Terms and Conditions.
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