ALEXANDRIA, VA (Oct. 8, 1999) -- Our up again, down again perennial bridesmaid stock International Paper (NYSE: IP) is up again, this time on excellent news that (dare I say it?) looks like it might stick.
"News" isn't exactly the right term. Rumor is more accurate. The company is due to report earnings next Tuesday and the "news" is that it is expected to make estimates even after taking a hit from Hurricane Floyd in the closing days of the quarter.
IP closed up almost 3% today and has actually been going up all week. (Kinda makes you wonder just how secure those earnings numbers are!) What's even better is that the earnings estimates are in the range of $0.37 to $0.40 per share, a big increase considering that the company barely made $0.74 in all of last year and is actually in the hole by $0.06 this year.
Estimates for earnings going forward are rosy, too, with most analysts forecasting a 15% increase in EPS (earnings per share) for this year over last, and expecting EPS to more than double next year. Wonder where I am getting all these cool numbers? Click here for estimates and here for actual earnings, courtesy of Quote.Fool.com.
You will notice an interesting thing if you compare the earnings numbers of those two pages. It illustrates one of the problems that plague serious stock researchers. According to the earnings page, IP earned $0.74 last year, but the estimates page shows it earning $1.00 for fiscal 1998. Both numbers are "right." The lower number is the actual earnings per share. The higher number has been adjusted for one-time charges, or "special items." Depending on the context, either number is appropriate.
One-time charges are costs associated with something like a corporate restructuring, the purchase of another company, the sale or spin-off of a division, the closing of an unprofitable subsidiary, mergers, etc. These are real costs that come out of the company's bottom line and, ultimately, out of the shareholder's pockets, but they often result in better earnings down the road.
Then there is the other side of the one-time coin: profits from the sale of a division, special tax breaks, etc. In both cases, these one-time charges don't really relate to the company's future earnings. A one-time windfall from the sale of a piece of vacant land is not something that is going to help next quarter's revenues.
So in the context of profits from ongoing operations, one-time charges and profits are really irrelevant. When analysts look at earnings, then, they usually back those numbers out and look at how the company would have done if those one-time events had not occurred. In IP's case, a whole bunch of special items impacted its EPS during the last half of last year and the second quarter of this year. If you like, you can read the press releases.
So shareholders would look at last year and conclude that the company earned $0.74 per share, but an analyst would look at last year's numbers and say the company earned $1.00 from continuing operations.
This is an important distinction and IP illustrates why. The consensus estimate for fiscal year 1999 is for the company to earn $1.15, which is a 15% increase over last year's adjusted EPS, but a 55% increase if you used the actual earnings. Using actual earnings when comparing current earnings with past EPS is like having a baby and then getting all excited because you "lost" 20 pounds.
So far, the yearly increase is modest, but it doesn't tell the full story. If you look just at the quarterly numbers, you get a very respectable growth rate. For the quarter ending in September of 1998, the company earned $0.25 per share (adjusted for special items) compared with, let's say, $0.40 this year. That's a 60% increase over the "same quarter previous year." That's a quite legitimate comparison and, in a case like this where the company is coming out of a slump, a better indicator of what is happening than the full-year numbers, provided you don't expect that kind of growth to continue for more than a year or two.
How do those estimates translate to stock price? Well, I'm going to go out on a limb here, but if the company doesn't run into any additional problems, and the international markets continue to strengthen, and the merger with Union Camp generates the operating efficiencies that are hoped for, we could see a price of at least $60 by the end of this year or early next year. That would be a 40% return for the Foolish Four portfolio's IP holdings, by the way.
You're wondering where that number came from, right? OK, here's the math. Right now the company is selling for around $47. That's 47 times its 1998 earnings ($1.00), and, once you adjust for special items, about 55 times its trailing earnings (the last four quarters, adjusted for special items, i.e., $0.84). If the company earns $1.15 this year and the market continues to value it at the same price-to-earnings ratio (P/E), that would put the price around $63 (55 x $1.15). But if the market gets excited about the prospects for next year, an even higher price would not be surprising.
Estimates call for earnings of $2.76 in fiscal year 2000. That's growth staid old paper companies rarely see and could justify a price of, sit down, around $150 with a constant P/E. Now, I doubt that IP will go that high, although the merger with Union Camp certainly holds forth the promise of higher profit margins (which are razor thin right now). What seems more likely to me is that the relatively high P/E that IP has today is in anticipation of its recovery, so there's no reason to anticipate that the P/E will grow or even stay as high. But even a very modest (by today's standards) P/E of 36 would justify a price of $100 per share by the end of next year.
After three years as the Foolish Four stock we all love to hate, I think IP may be due for some lovin'.
Fool on and prosper!