Is International Paper's Dividend Safe? We Think So

Shares of International Paper plunged 11% on Friday after FedEx warned of weaker shipping volumes and an analyst downgraded the stock citing an inventory glut in materials used to make cardboard boxes.

International Paper generates around 85% of its sales from making linerboard and heavy-duty cardboard boxes used to move food and beverages (45% of sales), other non-durables such as chemicals and tissues (30%), and durable goods used in e-commerce and shipping (25%).

This is a cyclical business; U.S. corrugated packaging shipments fell around 6% during the early 2000s recession and by about 12% when the financial crisis struck in 2008-09.
Source: International Paper
When box demand falls and inventory builds, rivals can become more aggressive on price to move product and keep their capital-intensive mills humming.

Higher input costs in today's inflationary environment could magnify the effect of softer pricing, and downturns can become more severe if additional containerboard capacity comes online during inopportune market conditions.

None of these headwinds are new to International Paper, which has weathered many storms since its founding in 1898.

As the largest containerboard maker in North America, around 90% of the firm's capacity sits in the first quartile on the global cost curve. This low-cost position helps the firm generate positive free cash flow in all manner of economic environments.

International Paper's BBB rated balance sheet is also the healthiest it has been in at least a decade as management in recent years has prioritized debt reduction and avoided making major acquisitions.

Leverage ended 2021 at 2.3x according to Moody's, sitting below International Paper's target range of 2.5x to 2.8x. Debt maturities over the next five years are also limited at about $900 million, or about half of the annual free cash flow the firm has historically generated.

We can't predict the timing or magnitude of the next cyclical downturn in containerboard. But International Paper's financial position gives us enough confidence to reaffirm the company's Safe Dividend Safety Score despite some storm clouds on the horizon.

Aside from a 10% dividend reduction related to International Paper's 2021 divestiture of its lower-margin printing papers business, which accounted for about 20% of sales, the company has only cut its dividend once since making its first payout in 1946.

That cut took place in 2009 and was caused by the company's highly leveraged balance sheet, which swelled in 2008 after completing a $6 billion deal to buy Weyerhaeuser's packaging assets.
 
This risk is not present today, and the industry should arguably have more pricing discipline given the significant consolidation that has taken place over the past decade. 

That said, income investors considering the stock must be comfortable with the company's cyclicality. 

Even if long-term box demand grows slowly but steadily thanks to stable shipments in core markets like food manufacturing and increased e-commerce activity, the industry is no stranger to occasionally falling on a year or two of hard times.

We will continue monitoring International Paper's results and provide updates as needed.

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