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International Paper A High-Risk Play

Posted: Mar 11, 2009 12:17 PM by Eric Fox

Tickers in this Article: IP, SSCC, WY, LPX, MWV

As the market discounts a depression-like scenario to the economy, some of America's most storied names are selling in the single digits. One such name is International Paper (NYSE:IP), which can now be bought for the same price it sold for in 1986. Is this the buy of a lifetime or a value trap for unwary investors?

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Fourth Quarter Earnings
International Paper reported earnings in late January, and as expected, the results were not good. The company reported a GAAP net loss of $1.07 per share, or $452 million. This loss was not as bad as it appeared, because it contained a $1.04 per share goodwill impairment charge. The company ended the year with $1.1 billion cash. While this may sound like a lot, it pales in comparison to 2008's end-of-year debt of $12.07 billion.

Cutting Costs
International Paper has taken several actions to cope with the downturn in its business. It cut its dividend by 90%, saving approximately $100 million every quarter. The company announced the sale of 143,000 acres of timberland in exchange for $220 million in cash, and a 20% ownership in the fund that purchased the property. IP's capital spending for 2009 was cut to $700 million, from $1 billion in 2008. This is significant because as of the end of 2008, the company has $828 million in debt that is classified as current on its balance sheet, meaning that it must be paid back within a year. During its conference call in January, the company said it paid off $362 million of this debt in the first quarter of 2009, and was renegotiating an extension of a 500 million euro note. (Learn about the components of the statement of financial position and how they relate to each other in our article, Reading The Balance Sheet.)

In order to cope with the downturn, many other paper companies are also cutting capacity and costs. Since the beginning of the year, Weyerhauser (NYSE:WY) announced the closure of three mills - one in Alabama and two in Washington. The company reported a net loss of $1.21 billion, or $5.73 per share for 2008, including a goodwill write-down of $827 million. Louisiana Pacific (NYSE:LPX), a maker of building products, closed four plants, suspended its dividend and cut capital expenditures to the minimum level.

Covenants
International Paper has two covenants to deal with in 2009. The company must maintain a maximum debt to capital of 60%, and a minimum net worth of $9 billion. At the end of 2008, IP had a debt to capital of 52%, and a net worth of $11.2 billion. High debt levels crushed the industry last year. Smurfit Stone Container (Nasdaq:SSCC) filed for bankruptcy with $5.6 billion in debt. The company has a 19% share of the North American containerboard market, second only to the International Paper's 29% share.

Input Costs
The one piece of good news in the report was a significant easing of input costs for the company in the fourth quarter. International Paper saw input prices rise to the equivalent of $1.38 per share in 2008 vs. 2007. MeadWestvaco (NYSE:MWV) also saw some relief in the fourth quarter due to the easing of oil prices, but the cost of other inputs, like caustic soda and sulfuric acid, were still high. MeadWestvaco did better than Weyerhauser or International Paper in 2008, reporting a GAAP profit of $0.52 per share.

Bottom Line
International Paper is trading at a 20-year low, laboring under a huge debt load and has been hurt by falling demand for its products. The company is actively managing the current environment by cutting costs and reducing capital spending, and will receive a nice tailwind from falling input prices. This is a higher risk play for investors with a strong stomach.

By Eric Fox

Eric J. Fox, is the founder of Brittain Capital Management, LLC., which manages the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at his blog - Stock Market Prognosticator.

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