An Obituary for the Paper Industry

| About: International Paper (IP)

Paper companies have been struggling in these difficult times. Not only do they have to deal with the recession, but they have to deal with fairly dramatic changes in their markets. In paper, the business market has been moving increasingly toward a paperless environment. Most documents are now sent by email; and/or they are stored on disk. Most are never printed on paper. Even newspapers have gone paperless. The Wall Street Journal is “Online”. Ditto the Investors Business Daily, and many if not most daily newspapers. Of course, most of these still publish a paper version, but the circulations of those paper versions has been falling for many years now. The fall in circulations is noticeable in the fall of newspaper stock prices. Additionally, International Paper (NYSE:IP) still has lawsuits pending over a Mississippi plant explosion which killed one and injured about 2 dozen others. These lawsuits will likely continue to hurt profits over the near term.

Even though paper equities are over the long haul trending downward, they can still make you money. In the latest 50+% run up from the march lows, the general recovery euphoria became so strong that even these struggling stocks benefitted. Some are significantly over valued at present. You can make money by shorting them as they likely retreat from their current price levels. Plus in late Sept. 2009, three US paper companies filed an antidumping complaint against Chinese and Indonesian paper makers. It takes a while for such a complaint to move through the Federal system. There won’t likely be any action in the immediate future. This means that the paper companies not only have to contend with declining markets and low prices, but unfair trade practices as well. In the short term the Chinese and Indonesian dumping has to hurt IP on the bottom line. It will be months before tariffs may be applied, if they are granted by the Obama administration. With a general market retracement trend seemingly in place now, paper company equities are likely to decline rapidly in the near term.

A general market down trend has started recently. This trend should help paper companies go down. This new trend can be seen in the chart of the SPY shown below:

You can see that a noticeable down trend started in early to mid Sept. The Money Flow chart indicates that money is still moving out of the SPY (which I am using as an indicator of the general market). The Relative Strength Index shows that this down trend is not very close to bottoming out. The Volume chart shows that the SPY is moving down on good volume. The fundamental fair value for the SPY is in the $85 to $88 range, so it has a fair ways it can move downward for fundamental reasons. All of these things are good signs if you are planning to short the market or a particular stock.

IP is one of the paper companies that will likely do poorly in the near term. Both the 3 month chart, which shows the near term down trend, and the 2 year chart, which shows the longer term down trend, illustrate that this stock should outperform to the downside in a market retracement.

The 3 month chart is most important for our purposes. It shows IP declining consistently near term. The Money Flow Index and the RSI are declining with the stock price. The Williams %R shows that IP is currently oversold, but the Relative Strength Index shows that it can remain over sold for quite some time yet. IP is right at the point of crossing its 50-day SMA line. This is a very bearish signal. It should be able to run a ways down from that point. That would be a normal expectation, especially in a declining market. Some possible support points are the 100-day and 200-day SMA lines. Plus if you look at the 2 year chart, you can see major support points at $18-$19, at $13-$16, and at $8-$9. IP bottomed at a little less than $4 in March.

That was then. This is now. The possibility of helpful tariffs looms in the future. The possibility of a recovery from the recession is much more real now. Bernanke has said the recession may be technically over. All this means that it is unlikely that IP will again go down to $4 near term. My first target would be about $19. The current price is $21.39. If IP breaks below $19, especially if it breaks below the 100-day SMA line, my next target would be approx. $16. At that point I would be getting out. The two legged climb from $4 to approx. $16 was rapid. The subsequent climb to approx. $25 was much slower. This shows that the upside push was tiring. IP is more likely to lose this reluctant price increase than the prior rapid increase.

IP is currently predicted to make money in 2010 and 2009. It deserves some respect. However, its general statistics do make it a candidate for a short. For instance, it has no TTM PE. The 2010 PE is over 22, and even this is above the long term average PE of approx. 15 for this industry. This stock is over priced even on a forward looking basis. It should move downward near term. Fundamentally a fair value in a recession recovery market might be a PE of 15 for 2010. If you adjust the stock price for the current FPE and the fair value FPE, you might say a fair stock price would be about $7 less than the current $21.39. Since there is good support at about $16, that might be a less risky place to exit a short position. However, if the general market reverses its trend due to earnings beats and positive economic news, I might think seriously about exiting a short position at $19 instead of waiting for $16. IP's Beta of 2.4 should also help it to move down quickly as the overall market moves downward. For more fundamental details about IP please see the table below.

Stock Name
International Paper (IP)
Price at close 10/2/09
NA – negative earnings TTM
2009 PE
2010 PE
% Held by Institutions
Short Interest
Price to Cash Flow
Price to Book
Debt to Capital Ratio
Quick Ratio
Return on Equity
Return on Investment
EPS Growth (MRQ)
EPS Growth (TTM)
Revenue Growth (MRQ)
Revenue Growth (TTM)
Dividend Yield
Net Profit Margin

Notably IP has some cash flow problems. The PCF number is poor. The Price to Book ratio is also higher at 1.91 than the industry median of 0.86. The ROE, ROI, and EPS Growth numbers are bad, although going forward these should improve. The Net Margin number is bad. With China and Indonesia apparently dumping in the US, this number seems likely to continue to be a problem in the near term. In sum the prospects of this stock’s price rising demonstrably in the near future are poor. The prospects of IP’s stock price falling are good. The imminent cross of the 50-day SMA line is very bearish. The apparent retracement mode of the S&P500 is helpful to a down movement in the IP stock price, especially given its 2.4 Beta. The dumping is helpful to a short position.

I currently do not have a position in IP stock. I may establish one soon (perhaps Monday). If you elect to pursue this trade, pay close attention to any announcements about tariffs. I do not expect any in the next month. I expect instead this trade to be over within the next month. IP reports earnings on 10/28/2009. You may wish to be out of this trade before then in order to decrease you risk.

Disclosure: No positions.