“In Friday’s game plan, I told you to keep an eye on International Paper, which just reported its fourth quarter today. This manufacturer of all kinds of paper from loose leaf and industrial package and container board, is a fabulous indicator of the global economy’s health. Given the stock took a shellacking today, down 5.6%, you might think it’s signaling bad things about the recovery, not just its own business. Even with the tough decline, International Paper is up 4% since the last time we spoke to the CEO on September 25th. Then the stock was at $21.71.
What happened? Company earned 24 cents. That’s a penny better than Wall Street expected. It did have a 4 cent benefit from a lower tax rate. Some people would say it fell short of the bean counting analysts, what they were looking for.” — CNBC’s Mad Money 2/3/2010
Following the interview with International Paper (IP) CEO John Faraci, Cramer boasted that IP is currently the cheapest stock in the world and is “ready to roll”. Of course, there is no way that this claim can be proven without the benefit of hindsight, but we beg to differ as we believe the current valuation is entirely fair. Remember that the stock has nearly tripled in the last twelve months, and is about 6x higher than its lows for the year last March. As Cramer mentioned they reported fiscal fourth quarter and full year 2009 results which at first glance appeared to be better than expectations. However, the earnings beat was aided by favorable tax rates as sales were 8.7% lower than a year ago, and the market sold off in reaction.
Faraci noted that International Paper’s business is short-cycle and benefits from the initial signs of recovery, and that certainly seems to be the case for most basic materials bellwethers. The first signs of recovery, no matter how faint, were about a year ago now (when we had the stock rated Undervalued) which somewhat explains the stock’s rapid rise. Now, we are at the point where the market has rallied so strongly over the past year that current valuations are having a harder time being justified by the potentially slower than hoped recovery. In our opinion, the past quarter was the weakest of their past year, and even the CEO himself admitted to being disappointed as his company, “left a few pennies on the table.”
At Ockham, we have the stock currently rated as Fairly Valued, and can think of many stocks that have a more attractive valuation than IP. Cramer said that he has been following this stock for 30 years and believes the cash flow has never been more attractive. We utilize cash earnings in our analysis which are reported earnings that strip out non-cash items rather than cash flow. Our historical analysis shows that IP traditional trades for anywhere from 17.5x to 30.4x cash earnings, and the current price-to-cash earnings is within that range at 21.6x.
IP has yet to start raising its dividend that was hacked when the company needed to conserve cash last spring. Full year sales were down 5.5% from a year ago and the stock rose quite a bit last year, we think there are plenty of more attractive stocks for long term value investors. Unlike Cramer, we found the CEO admitting sub-optimal performance in the last quarter a bit worrisome. We would hold off unless the stock fell back down below $20, which would make the valuation far more attractive.