International Paper (IP) and MeadWestvaco (MWV) are two basic materials that the Street currently rates a "strong buy." Both are up solidly for the year to date, but, in my view, only International Paper has solid momentum going forward. Based on my multiples analysis and DCF model, I find that International Paper will significantly outperform MWV over the next year or so.
From a multiples perspective, International Paper is the cheaper of the two. It trades at a respective 10.4x and 10.8x past and forward earnings while MWV trades at a respective 16x and 14.9x past and forward earnings. While both come with a great deal of volatility, they reduce risk by offering a high dividend yield of 3.2%. With concerns about inflation looming, however, gold will continue to attract the risk-averse investors. Freeport (FCX) trades at only a respective 9x and 7.7x past and forward earnings. Despite these multiples, as I warn here, Freeport is no longer the defensive play that it once was.
At the third-quarter earnings call, International Paper's CEO, John Faraci, noted stellar performance:
[W]e're pretty pleased, very pleased with our third quarter results. I think the $0.92 a share reflects the global balance of International Paper. Our focus businesses continue to produce strong earnings and free cash flow. Basically, it was steady volumes and a weak economic environment, stable pricing, outstanding operations, very strong contributions from our joint venture in Russia. We also set input cost escalation and achieved costs of capital returns. And if you think about our earnings, they're substantially up from the second quarter. And adjusting the third quarter 2010 for a land sale, they were up 11% relative to the third quarter of last year.
Furthermore, the company finished December with solid performance. Pulp pricing appears to be at a trough in China and ROIC is forecasted to expand by nearly 250 bps by 2013. With the media being overly negative about the box and paper businesses in Europe, it may surprise investors to learn that these segments are actually doing quite well. Underlying demand is shifting to the right just as the $3.7B Temple-Inland deal closes to help unlock cost synergies and grow margins.
Consensus estimates for International Paper's EPS forecast that it will grow by 50.2% to $3.08 in 2011, decline by 2.3% in 2012, and then grow by 8.3% in 2013. Assuming a multiple of 15x and a conservative 2012 EPS of $2.96, the rough intrinsic value of the stock is $44.40, implying 36.8% upside. Modeling a CAGR of 16.7% for EPS over the next three years and then discounting backward at a WACC of 9% yields a fair value figure of $41.13 - still more than sizable enough to merit an investment.
MWV, on the other hand, is more talk. Management speaks about its 3%-4% annual savings target, its 5% organic growth target, and upward of 100 bps margin improvement target. But with Europe reeducating inventories and pricing pressures cutting into margins, these goals may be out of touch with reality. On the positive side, the recent acquisition of Polytop Corp will expand the company's scale in dispensing systems and consumer production. I am further attracted to management's enthusiasm about penetration in China, India, and Brazil. The use of joint ventures in India and the Reigesa expansion in Brazil all appear to be proceeding smoothly, but only time will tell.
Consensus estimates for MWV's EPS forecast that it will grow by 24% to $1.91 in 2011 and then by 2.1% and 13.8% more in the following two years. Assuming a multiple of 15x and a conservative 2012 EPS of $1.93, the rough intrinsic value of the stock is $28.95, implying 8.4% upside. Thus, even though MWV and International Paper are both rated a "strong buy" on the Street, the latter comes out as the clear winner.