(By Mani) International Paper Co. (NYSE:IP
) has immense potential to raise its dividend given its strong cash flow, making the shares attractive for income seeking investors.
The company's recent investor day presentations showed that its free cash flow is likely to remain relatively strong over the next few years, and the company targets $2.2 billion in free cash flow (FCF).
Over the past 4-5 years, the company has done an impressive job of improving performance and cash generation from its operating businesses. Pulling the "crutch" of timber harvest cashflows away as well as poorly-disclosed land sale gains has forced its operating businesses to improve. Industry consolidation and a weak US dollar have also helped.
International Paper is pointing to a dividend payout ratio of 30-40 percent of midcycle FCF potential of $2.2 billion. This implies dividends of $650 million to $850 million or $1.45 - $1.95 a share.
IP is pointing to steadily raising dividends overtime, reducing debt, pension-funding and "selective reinvestment".
"In the near-term, we think IP could raise its dividend to $1.15-1.20/share, an increase of 10-15% from current levels. Debt reduction & pension contributions are the other near-term priorities for cash," Deutsche Bank analyst Mark Wilde wrote in a note to clients.
While IP provided no specifics or order of priority for returning cash to shareholders, IP seems to be less inclined toward share repurchases or further acquisitions at this time.
Wilde estimate that IP would generate EBITDA of $4.1 billion in 2013. With estimated capex of $1.4 billion, 35 percent cash tax rate, about 655 million in cash interest expense, and $125 million in equity income, net of minority interest, IP should be able to generate $1.5 billion in free cash flow.
The midpoint of the 30-40 percent payout ratio guidance range implies a dividend of $525 million or about $1.20 a share on the current share count. At the current share price, $1.20 a share dividend will provide investors with a yield of 4.1 percent, placing IP among the highest yielding stocks in the industry. Rival Domtar Corp. (NYSE:UFS) offers dividend yield of 1.8 percent, while MeadWestvaco Corp. (NYSE :MWV) yield amounts to 3.6 percent.
"While IP did not provide any timeline on a dividend move, we think with the cash from the sale of 3 mills, ramp-up in earnings from Temple acquisition & realization of deal synergies, an announcement in late-Q3/Q4'12 appears likely to us," the analyst added.
Moreover, International Paper's current dividend offers a yield of 3.6 percent, better than the Treasury yield of 0.70 percent, 1.63 percent, 2.74 percent for 5, 10 and 30-year bonds respectively.
The company's three-year average dividend growth rate was 75.27 percent, while 5-year average stand at 40.66 percent. It has returned only 1.65 percent on investment in the last twelve months, but it has returned 115 percent in the last three years.
Tennessee-based International Paper is the largest and most globally-oriented North American paper company. The company's recent acquisition of Temple-Inland will increase its net containerboard capacity to 13 million and its market share to 34 percent from 27 percent. The company, which has significant positions in bleached paperboard and market pulp, is expanding its footprint in emerging markets like China (Sun JV), Russia (Ilim), and India (APPM). The company enjoys solid margins in most businesses and is generating impressive, free cash flow.