International Paper

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

International Paper is a global producer of renewable fiber-based packaging and pulp, with a diverse geographical footprint spanning North America, Europe, and Latin America, catering to a variety of industries.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

International Paper (IP) operates in a mature industry with several long-term contracts, facing competition based on price.

Business Overview

International Paper is primarily engaged in the production of packaging materials and pulp.

  • Industrial Packaging: This segment is the largest contributor to revenues, producing corrugated packaging solutions, including boxes, containers, and other shipping supplies that go into product delivery. It’s very cyclical.
  • Global Cellulose Fibers: This segment produces pulp, which is a raw material used in many different applications, including paper, tissues, and absorbent hygiene products. Global cellulose markets have become increasingly competitive due to commoditized products, resulting in pressure on pricing and margins, with new supply coming online in recent years.

The company’s operations are global, with a focus on North America, Europe, and Latin America. Their products serve a wide array of industries, from food and beverage to e-commerce and industrial applications.

Competitive Landscape

The paper and packaging industry is highly competitive and cyclical, with low barriers to entry.

  • Price Competition: IP primarily competes on price, which can create downward pressure on margins.
  • Supply and Demand Fluctuations: The cyclical nature of the industry often leads to volatility in earnings and cash flows.
  • Technological Innovation: Although it is a relatively mature industry, new packaging materials that can be cost effective and sustainable continue to put pressure on prices.
  • Consolidation: Recent mergers and acquisitions have led to increased competition and pricing pressure.

The paper industry is highly fragmented and cyclical.

Financial Analysis

Here’s a detailed analysis of the financial statements for International Paper (IP), with an emphasis on the most recent results.

Income Statement

Recent Performance (Q1, 2024):

  • Net Sales: $4,611 million. Down 4.7% compared to the same quarter last year. This is primarily due to declines in demand for their products and pricing pressures.
  • Cost of Goods Sold: $4,248 million, reflecting a high 92% ratio of cost of sales to revenue which is slightly more than the previous quarter.
  • Selling, General, and Administrative Expenses (SG&A): $394 million.
  • Net Loss: ($131) million, significantly down compared to a net profit of $440 million in the same quarter of the previous year.
  • Operating Earnings: $98 million, down from $464 million last year which indicates significant challenges in performance. This is mostly related to decreased volumes.
  • Operating Margin: The operating margin in this quarter is down to 2.1%, while it was 10.4% in the same quarter last year. This sharp decline indicates that there are significant challenges to the company profitability.

These results show a significant downturn in sales and profitability compared to the previous year.

Historical Trends:

  • Volatile Revenue: IP’s revenue has seen wide fluctuations due to industry cyclicality. Their sales figures range from $18 to over $21 billion in the years between 2018 to 2023. This trend seems to continue. The latest quarter shows a substantial drop compared to the same quarter last year.
  • Inconsistent Margins: Despite reasonable margins earlier, these have come under pressure in recent periods as a consequence of higher input costs and increased competition.

Balance Sheet

Recent Balance Sheet Health (Q1, 2024):

  • Total Assets: $22,383 million, a decrease from $23,361 million at the end of December 2021.
  • Total Liabilities: $18,864 million, down from $19,404 at the end of December 2021.
  • Cash and Cash Equivalents: Increased to $1.6 billion as compared to $1.1 billion from December 2021.
  • Net Debt: $1,314 million, an increase from $752 million.
  • Equity: The equity has decreased to $3,520 million.

IP’s recent balance sheet shows increased debt, lowered equity, and increased cash.

Historical Trends:

  • Moderate Debt Levels: IP’s debt has been significant but at manageable levels, with debt-to-equity ratio fluctuating depending on operating conditions and economic cycles.
  • Intangible Assets: A significant portion of its assets is tied to goodwill, acquired from previous acquisitions.

Cash Flow

Recent trends in cash flow:

  • Cash from operations was $1.341 billion for Q1 of 2024.
  • The company is focusing on improving free cash flow, even in the face of declining revenues, which is important for long-term value creation.

In the last few years, IP has focused on returning money to shareholders instead of focusing on investing in the growth of the company.

Historical Trends:

  • Capital Expenditures: While IP spends a sizeable amount on CAPEX, it is mostly to keep operations going, not for massive expansion.
  • Cyclical Cash Flow: Like earnings, cash flow is very much dependent on the state of the market and is therefore cyclical in nature.

Moat Analysis

Moat Rating: 2 / 5

International Paper possesses a narrow moat at best because it does not have a high quality or defensible competitive advantage over its peers. While they can sustain some returns due to their size, established contracts, and customer base, the price-based competition creates limitations on those returns. Their current ROIC is too low to be seen as a wide-moat company.

Sources of Competitive Advantage (or Lack Thereof):

  • Economies of Scale: IP benefits from the size of its operations. This provides some cost advantages but does not offer any significant pricing power.
  • Brand Recognition: Despite being an established company, IP’s brands do not command a premium over competitors. Their business isn’t built on brand power, rather it is mostly commodity.
  • Customer Switching Costs: There are negligible switching costs for customers; paper and packaging is a highly commodified space, which means customers will likely move towards the cheapest source with minimal consequences.

Despite having some advantages due to size and scale, IP fails to possess a substantial moat which makes their business more vulnerable to competitive pressures.

Legitimate Risks Affecting Moat and Business Resilience

  1. Pricing Pressure: The highly commodified nature of their products results in constant price competition, which may limit their capacity for generating returns.
  2. Input Cost Volatility: Prices of raw materials such as wood pulp, energy, and chemicals are highly volatile. As such, they directly affect the company’s operations.
  3. Industry Cyclicality: The paper and packaging industry is very cyclical, marked by periods of boom and bust, making earnings and cash flow predictions difficult.
  4. Technological Disruption: New forms of packaging that are more sustainable or cheaper can undermine the demand for IP’s products.
  5. Economic Downturn: Economic contractions can directly impact demand for industrial and consumer packaging, which would reduce IP’s sales and profitability.
  6. Mergers and acquisitions: Increasing consolidation in the industry may create larger competitors that may increase the pricing pressure for IP.
  7. Global Economic Uncertainty: Given the global presence of the company, any type of geopolitical turmoil will have a significant impact on the business.

Business Resilience

International Paper has demonstrated an ability to withstand economic challenges to a certain degree due to its size and diversification. However, their business is still vulnerable to various macro-economic and industry specific factors. The highly cyclical business environment and strong competition, in addition to lack of innovation in products, puts pressure on growth. Thus the resilience of the business is limited as margins can be compressed and revenues can swing quite dramatically from year-to-year, which puts it in a vulnerable position when unexpected factors occur.

Understandability Rating

Understandability Rating: 2 / 5

While the basic operations of producing packaging and pulp are relatively straightforward, understanding the dynamics of this commodity industry and the various factors affecting the pricing is complex. Furthermore, the accounting practices regarding acquisitions and large scale investments, and nonrecurring events make it hard to get a clean view of the underlying performance of the business.

Balance Sheet Health

Balance Sheet Health Rating: 3 / 5 The company’s debt levels are manageable, however, the increase in net debt, plus the significant intangible assets, and volatility of cash flows makes this a middle-of-the-road balance sheet.

  • Positive Points: International Paper is still a very large corporation and possesses a high credit rating, which enables them to borrow at favorable interest rates and avoid any liquidity related issues.
  • Negative points: The company’s net debt has been steadily rising, while the equity has decreased, and their net tangible assets are not as impressive as their total assets because it includes a substantial amount of goodwill.

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