An Old Economy Firm Ready to Rebound
This stock offers 20%-plus expected returns.
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International Paper Co.
Moat: None | FV Uncertainty: Medium | Price/Fair Value Ratio*: 0.73 | Three-Year Expected Annual Return*: 22.5%
What It Does: International Paper (IP) is a global paper and packaging company with operations in the United States, Europe, South America, and Asia. The company's primary business segments are uncoated paper and packaging. IP also runs a North American merchant distribution business. The company owns or manages about 300,000 timberland acres in the U.S. and 250,000 acres in Brazil, with harvesting rights on government-owned acres in Russia.
What Gives It an Edge: Despite a positive view of the firm's prospects, Morningstar analyst Daniel Rohr does not think that International Paper possesses a viable economic moat. The industry's cyclical nature means product demand and pricing can change dramatically, with overcapacity a common problem. Paper and packaging firms are also subject to volatile raw-material and energy prices. In addition, Rohr concludes that IP's ability to pass on rising input costs is circumscribed by its customers' strong bargaining position.
What the Risks Are: As a player in a cyclical industry, International Paper is at the mercy of fluctuating customer demand, which can strongly influence volume and pricing. Low-cost competition in South America and Asia also represents a risk to unit volume and pricing power. On the cost side, IP is subject to sometimes volatile and unpredictable prices for raw-material inputs and energy. Country-specific risks associated with joint ventures in Russia and China are also important factors to consider.
What the Market Is Missing: With the recent slide in International Paper's stock price, Rohr thinks the market is undervaluing the firm's emerging-market opportunities. According to Rohr, unlike many of its peers in the paper and packaging industry, whose fortunes are largely tied to the ebb and flow of North American paper consumption, IP is well-placed to profit from rising per capita paper consumption in emerging markets. The company used proceeds from a well-timed timberland sale to make major forays in Russia, China, and Brazil, which Rohr expects to deliver better returns on invested capital than its domestic operations. As a result, along with better growth opportunities, IP should remain more insulated than its peers to the struggling U.S. economy.
* Price/fair value ratios and expected returns calculated using fair value estimates, closing prices, and cost of equity estimates as of Friday, April 11, 2008.
Jeff Viksjo does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.