Are Shareholders Headed for a Short-Term Paper Cut?

People invest in the technology sector for cutting-edge inventions and the thrill of fast-paced growth. Investors in the paper sector -- well, let's just say they're a completely different breed.

The allure of paper product companies is fairly stable demand and often a reasonable dividend to boot. That's exactly what most shareholders have in mind when they purchase paper and packaging giant International Paper (NYSE: IP  ) . International Paper offers global diversification, 114 years of business experience, and a dividend north of 3%. However, based on its quarterly results last week and its pending merger with Temple-Inland (NYSE: TIN  ) , investors may also want to add heartburn to that list.

First of all, don't get me wrong in assuming that I'm a long-term International Paper bear, because its dividend and strong cash flow should, in all likelihood, turn you a profit over the long-term. What I am saying is that it may not be prudent to chase International Paper as it approaches a new 52-week high -- and here's why...

Merger-related hiccups
I don't care how confident IP's management is about its imminent merger with Temple-Inland -- I suspect there will be unforeseen merger-related hiccups. Mergers cost time and money and the layoffs that accompany them often result in short-term one-time expenses.

Over the long run, IP's takeover makes sense because its primary paper and distribution business has been stagnant for a decade. In fact, since 2002 IP's revenue has essentially been stuck between $22 billion and $26 billion. Without this merger, the reality of IP's anemic growth becomes brutally apparent.

Paper and pulp costs will rise
I'm aware that this will sound like the kid that cried wolf every day until the wolf actually came, but paper and pulp costs are going to rise. Currently, paper prices are in an uncharacteristically quiet period and IP even noted in its fourth-quarter results last week that its costs fell 3%.

Keep in mind, though, that paper prices tend to ebb and flow every couple of years. Paper prices saw dramatic rises in 2008 and 2010, so another bump in prices, and therefore IP's bottom line costs, could be in the cards sooner rather than later.

Where's the growth?
I'm not usually fan of lumping a sector into a pot and stirring the contents to get an overall consensus opinion, but I feel this is one instance where it makes sense. I don't see IP having a marked advantage over its peers, and frankly, its peers aren't doing all that well in the first place.

MeadWestvaco (NYSE: MWV  ) , which reported its fourth-quarter results two weeks ago, noted a 37% decline in net income and cautioned that lower volume across U.S. and European packaging markets makes its near-term visibility uncertain. Pulp and papermaker Domtar (NYSE: UFS  ) crushed Wall Street's EPS estimates on Friday, but that didn't save the company from forecasting that North American fine paper demand will fall by 2% to 4% in 2012. Weyerhaeuser (NYSE: WY  ) was the one exception to the rule, growing earnings by 40%, but it still reported widening losses in its wood products division.

Possible paper cut?
There isn't any momentum in the paper and pulp sector from a growth perspective (Weyerhaeuser's income jumped primarily from cost-cutting), yet many companies are trading as if there is -- International Paper most of all. Wall Street is only looking for 5% sales growth in 2012 and less than 2% in 2013, and even these figures may prove to be lofty if paper prices rise. My recommendation is to avoid International Paper until it has completed its merger with Temple-Inland and gets a few quarters of reporting as a merged company under its belt.

Will IP step out of the box and break its sales slump in 2012, or is it just more of the same for this cyclical behemoth? Share your thoughts in the comments section below and consider adding International Paper to your free and personalized watchlist.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He knows now that a woodchuck could chuck about 700 pounds of wood. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool owns shares of Weyerhaeuser. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that'll never draw blood.


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