Why Is International Paper Stock Dropping?

International Paper (NYSE:IP) had a really poor year compared to the major market averages, up just 2% versus the S&P 500, which posted a 24.7% gain.

Following a correction in the first half of last year, IP share price stabilized and plateaued, but what caused it to underwhelm by such a wide margin relative to the market and will it turnaround soon?

What You Need To Know About IP

As you might imagine, the paper and packing industry is quite cyclical and intrinsically tied to economic conditions, such as demand fluctuations in various sectors like construction, retail, and consumer goods.

There is no escaping these winds of fortune for International Paper as demand spikes during boom periods and turns down during bust phases, putting pressure on prices.

But IP has been around the proverbial block and survived during many ups and downs in the broader economy, and that track record is one of its appealing aspects alongside a handsome dividend.

Currently that dividend sits at 5.06%, rivaling the payout of 3-month Treasury bills at this time. As Shakespeare famously wrote, though, all that glitters is not gold, and the high yield masks an even higher payout ratio of 254%, suggesting it may not be sustainable for very long.

Another reason to be concerned about International Paper is that revenues have been slowing and turned decidedly negative last year. From a Q1 2022 high of 14% year-over-year revenue growth, or $5.2 billion, the top line fell by 14.6% in Q3 2023 to just $4.6 billion.

In spite of the top line struggles, management does deserve a pat on the back for keeping earnings before interest and taxes steady in the hundreds of millions. Last quarter, EBIT came in at $290 million, though that was the second lowest figure reported over the past 3 years.

That profit may not be enough to stem the tide on the balance sheet woes, which are disconcerting with $1.1 billion of cash being offset by more than $5.5 billion of long-term debt. Nonetheless, management should be lauded for producing positive levered free cash flow in 10 of the past 12 quarters in spite of the high debt load and dividend obligation to shareholders.

Plus, International Paper has a few other aces up its sleeves.

3 Reasons to Own International Paper Stock

IP enjoys a strong and broad customer base across various sectors that provide revenue stability and buffer it against sector-specific downturns. Those relationships are long-term in nature and provide an intangible asset that leads to a predictive flow of steady orders. The challenge for the firm is to expand on this customer base in order to drive sustainable growth.

Management has also been successful in driving innovation through eco-friendly packaging solutions, such as sustainable packaging and recyclable materials. The investment in research and development to evolve is precisely what the enterprise needs to broaden the revenue mix and separate itself from rivals.

An often overlooked aspect of the firm, but a key attribute at the same time, is its supply chain that leads to cost efficiencies in production and distribution as well as competitive pricing to preserve profit margins. Not only does the firm have extensive customer partnerships but so too does it enjoy relationships with strategic suppliers and distributors that are essential to seamless operations.

The result is a successful operation across a broad swath of geographic regions, leading to a buffer against local downturns and a diverse revenue mix. It also contributes to the firm’s moat, which can be summed up as having economies of scale that lead to operational efficiencies which rivals can’t easily compete with. For example, IP can optimize production and distribution networks to lower costs and boost margins.

The Good, Bad and Ugly of IP

If you were to sum up the pros and cons of owning International Paper stock at this time, the pluses include a significant dividend and the commitment of the Board to repurchase shares. In 2021, a $2 billion share buyback scheme was announced and $679 million was returned to shareholders either through dividends or buybacks in the first 9 months of 2023.

In spite of the slowing revenue trend, the company has managed to report a profit over the past twelve months. And conservative investors will find the low share price volatility to be quite appealing.

On the downside, the revenue decline has been occurring at an accelerating rate and net income is forecast to drop this year. In addition, the sustainability of the dividend is very much in question given the enormous payout ratio.

It’s fair to say when the pros and cons are put into the mix, analysts are not overly enthusiastic about the prospects for IP share price with the consensus estimate sitting at $37.58 per share, which mirrors a discounted cash flow forecast analysis.

So, what explains away the share price underperformance?

Why Is International Paper Stock Dropping?

International Paper stock has been dropping relative to the market because of a sharp decline in revenues year-over-year. That fall has led to lower profitability and it’s unclear what could spark a turnaround in the near-term. 

In addition, a cut in the dividend could result in income-seeking investors fleeing the stock, which would lead to an outflow of capital and, if history repeats, a fall in the share price.

For now, IP has some advantages but not enough to provide a compelling investment case to buy now, particularly with limited upside to fair value based on both analysts’ consensus and a cash flows analysis.

The bottom line is the high debt level and slowing revenues are enough to keep prospective buyers sitting on the sidelines for better prices and a higher margin of safety in the future.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.