In my view, the stock of International Paper (NYSE:IP) is an excellent candidate to be included in diversified large-cap dividend stock portfolio. The company generates strong cash flow and pays a generous dividend currently yielding 4.12%. Moreover, the annual rate of dividend growth over the past five years was very high at 32.6%.
International Paper is a global leader in packaging and paper with manufacturing operations in North America, Europe, Latin America, Russia, Asia and North Africa. Its businesses include industrial and consumer packaging along with uncoated papers and pulp. The company was founded in 1898 and is headquartered in Memphis, Tennessee.
Latest Quarter Results
On April 27, International Paper reported its first-quarter 2016 financial results, which beat adjusted earnings-per-share expectations by a significant margin of $0.11 (15.9%). The company posted revenue of $5.11 billion in the period, missing Street forecasts of $5.20 billion. IP has shown earnings-per-share surprise in all its last four quarters, as shown in the table below.
Source: Yahoo Finance
In the report, Mark Sutton, Chairman and Chief Executive Officer, said:
International Paper delivered a solid first quarter driven by continued strong results from North American Industrial Packaging and improving performance in our papers businesses around the globe. Demand outlook is positive and we remain focused on productivity improvements, allocating capital to high return investments and generating free cash flow. I am confident in our ability to continue to create value through the generation of high returns on capital while returning cash to shareholders.
Major asset purchase from Weyerhaeuser
On May 2, 2016, International Paper announced that it has entered into a definitive agreement to purchase Weyerhaeuser's pulp business. Under terms of the agreement, IP will acquire five pulp mills and two converting facilities that produce fluff pulp, softwood pulp, and specialty pulp for a number of consumer applications including diapers, other hygiene products, tissue, and textiles.
According to the company, because the transaction is a purchase of assets, it expects to realize a tax benefit with an estimated net present value of approximately $300 million. Including this benefit, the net price is approximately $1.9 billion. International Paper forecasts annual synergies of approximately $175 million by the end of 2018, which will require the need for one-time costs of approximately $85 million. The acquisition is expected to close in the fourth quarter of 2016, subject to certain closing conditions, primarily the receipt of regulatory approval.
As I see it, the purchase of Weyerhaeuser's pulp business is a smart move by IP. According to the company, the transaction will position it as the premier global supplier of fluff pulp and will enhance its ability to generate additional free cash flow. Although IP's forecast of annual synergies of approximately $175 million by the end of 2018 might appear exaggerated, I believe that it is possible since IP has a great record of successful large transactions with synergy gains. What's more, in my view, IP is not paying an excessive price for the transaction, Weyerhaeuser's assets have a total annual production capacity of almost 1.9 million metric tons, and IP said it is paying 5.4 times the target's 2015 earnings before interest, taxes, depreciation and amortization. That is less than the multiple paid in six comparable deals over the past five years, according to data compiled by Bloomberg. The deal is International Paper's largest since its $4.27 billion acquisition of rival corrugated packaging manufacturer Temple-Inland in 2011.
IP has a considerable debt. However, it generates high free cash flow. Free cash flow was $311 million in the first quarter of 2016, compared to $ 319 million in the same quarter a year ago, and $501 million at the previous quarter. At the end of the first quarter, the company had cash and cash equivalents of $1.16 billion, and long-term debt of $8.82 billion. IP's debt to capital ratio was 68.8%, down from 70.3% at the end of the fourth quarter of 2015. Standard & Poor's rates the company's debt as Baa2 stable.
Dividend and Share Repurchase
IP pays a generous dividend, in December 2015, the company raised its annualized dividend by 10% to $1.76 per share. The current annual yield is at 4.12%, and the payout ratio is at 72.7%. The current yield is historically high, which indicates that the stock is undervalued, according to some dividend assessment theories. The annual rate of dividend growth over the past three years was high at 14.7%, over the past five years was very high at 32.6%, and over the last ten years was at 5.1%.
IP repurchased $100 million of its stock in the first quarter of 2016, and the company said that it will continue to repurchase stock opportunistically.
Since the beginning of the year, IP's stock is up 13.2% while the S&P 500 Index has increased 1.9%, and the Nasdaq Composite Index has lost 3.4%. However, since the beginning of 2012, IP's stock has gained only 44.2%. In this period, the S&P 500 Index has increased 65.7%, and the Nasdaq Composite Index has risen 85.7%. According to TipRanks, the average target price of the top analysts is at $45.67, an upside of 7.0% from its June 20 close price, which appears reasonable, in my opinion.
IP Daily Chart
IP Weekly Chart
Charts: TradeStation Group, Inc.
IP's valuation is good. The trailing P/E is at 18.47, and the forward P/E is low at 11.65. The price to sales is very low at 0.80, and the price to cash flow is low at 8.03. Furthermore, the Enterprise Value/EBITDA ratio is very low at 8.93, and the PEG ratio is at 1.41.
International Paper delivered first-quarter results that were better than analysts' expectations. The company has shown a significant earnings-per-share surprise in all its last four quarters. Moreover, according to IP, demand outlook is positive, and the company remains focused on productivity improvements, allocating capital to high-return investments and generating free cash flow. As I see it, the purchase of Weyerhaeuser's pulp business is a smart move by IP, and it is not paying an excessive price for the transaction. According to the company, the transaction will position it as the premier global supplier of fluff pulp and will enhance its ability to generate additional free cash flow. IP's valuation is good, the forward P/E is low at 11.65, and the EV/EBITDA ratio is very low at 8.93. Moreover, IP generates high cash flow and returns substantial capital to its shareholders by stock buybacks and increasing dividend payments currently yielding 4.12%. The average target price of the top analysts is at $45.67, an upside of 7.0% from its June 20 close price, which appears reasonable, in my opinion.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.