International Paper Company (NYSE:IP) is a core position in our equity portfolio, which we sized up in the first quarter. IP has a compelling case for ownership buoyed by excellent sector and secular tailwinds.
With a current market capitalization of around $20 billion, IP is the largest player in the highlyconsolidated North American Containerboard (NACB) industry, which benefits from strong pricing power despite flat volumes due to nearly 100% operating rates…
IP has multiple near-term catalysts. The most immediate should come by the end of this month when the market learns if the industry’s latest price increase has been officially sanctioned. Proceeds from post-merger asset sales combined with IP’s robust pro forma cash flow should complete IP’s multi-year deleveraging, which has reduced debt by around $10 billion over the last four years. With a cleaner balance sheet and no opportunities for further acquisitions, we believe IP’s consistent cash flows will be returned increasingly to shareholders through buybacks and dividend increases. Even using stressed assumptions, IP should generate +$2.00 FCF per share, and we expect the dividend to rise to this level.
What impressed me the most from this letter is that Loeb is praising International Paper Company (NYSE:IP) and its CEO. Usually Loeb is bashing CEOs and angling for change. From the tone of this letter, he feels comfortable to sit back and let management do the work and make him money.
On the company’s earnings call, CEO John Faraci gave his assessment of IP as follows:
I just want to make sure investors understand this. IP is a cash flow story. We’re going to be approaching $2 billion of free cash flow in 2013. As we look at the year, we’re now over 4 months into it…we’re going to allocate that cash flow in a balanced way with a portion of it back to share owners.
Of the analysts that follow the stock, six have it rated as a Strong Buy, nine a Buy, and two a Hold. Price targets on the stock range from $51 to $60, with $54.50 being the median target, suggesting nearly 20% upside.
The industry
Some of the other major paper companies are also up nicely year to date. Packaging Corp Of America (NYSE:PKG) is up 24% year to date, while Clearwater Paper Corp (NYSE:CLW) is up 17%. Packaging Corp Of America (NYSE:PKG) is one of the largest producers of containerboard in the United States and also one of the largest manufacturers of corrugated packaging products.
Toward the end of last month, the company posted EPS of $0.62, compared to $0.42 for the same quarter last year, on the back of 12% higher sales year over year. Analysts expect Packaging Corp to grow revenue more than 11% in 2013 and then 4% in 2014. This should come on the back of a rebounding economy that boosts demand for corrugated packaging. The long-term prospects for Packaging Corp Of America (NYSE:PKG) are also robust, with analysts expecting the company to grow EPS at an annualized 15% over the next five years.
Clearwater Paper Corp (NYSE:CLW) produces pulp and paperboard at six facilities across the U.S. The company is a premier supplier of private label tissue to major retail grocery chains, and also produces bleached paperboard used by quality-conscious printers and packaging converters. Sales are expected to be up 5% in 2013 and 2014, with output from a new tissue machine boosting sales in 2013 thanks to a favorable product mix.
Demand for tissue should also expand along with a rebounding economy. This paper company posted EPS of $0.11 for the first quarter, compared to $0.42 for the same quarter last year and well below consensus of $0.57. Analysts are expecting 2013 EPS to be down by 10% from 2012; yet, analysts also expect the company to manage 15% annualized EPS growth over the next five years.
Hedge fund trade
Of the major peers, International Paper Company (NYSE:IP) had the maximum hedge fund interest going into 2013, with a total of 38 hedge funds long the stock. The top hedge fund owner by market value was Doug Silverman’s Senator Investment Group, with a $139 million position (check out Senator’s top picks).
Heading into 2013, there were 20 hedge funds long the stock. First Eagle Investment Management was the top fund owner with $165 million invested in the stock, which was a mere 0.6% of its portfolio. (see Packaging Corp’s other hedgie owners). For Clearwater, there were only 10 hedge funds long the stock, which does include a couple of big name hedge funds. Royce & Associates was the top hedge fund owner, while billionaire Steve Cohen was second with a $64 million position (check out Cohen’s small cap picks).
Don’t be fooled
International Paper appears to be very cheap. The company trades below major peers on a price to sales and a forward P/E basis.
| International Paper | MeadWestvaco | Packaging Corp | Rock-Tenn | Clearwater Paper | |
| Forward P/E | 9.10 | 16.50 | 13.80 | 10.90 | 1.30 |
| Price to sales | 0.69 | 1.08 | 1.57 | 0.76 | 0.56 |
What’s more is that when you couple the expected growth of International Paper Company (NYSE:IP) with its cheap valuation, the stock is easily a growth at a reasonable price opportunity, with a PEG ratio of 0.77, compared to Packaging Corp’s 1.4 and Clearwater Paper Corp (NYSE:CLW)’s 1.22. Oh, and the company also pays a dividend that yields 2.60%.
Loeb took a position in International Paper Company (NYSE:IP) during the first quarter of this year, and although he might not be happy about the earnings miss, the company is a cash flow story going forward. This sell-off is a great opportunity for new shareholders to take a position and buy the dip in International Paper.
The article Billionaire Dan Loeb Is Making Paper originally appeared on Fool.com and is written by Marshall Hargrave.
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