In just one week, on Thursday, Feb. 2, International Paper (NYSE:IP) is due to report its fiscal Q4 and full-year 2016 earnings -- but one analyst isn't waiting around for the good news. This morning, TheFly.com reports that megabanker Citigroup is upgrading shares of International Paper to buy, and assigning the stock a new and improved price target of $67 per share.
That's about 13.6% more than Citi previously thought the stock was worth, and relative to today's share price of just under $58, implies International Paper stock could rise nearly 16% in value over the course of this year. Throw in a hefty 3.3% dividend yield, and that's a potential 19%-plus profit over the next 12 months -- if Citigroup is right.
Is it right? Here are three things you need to know.
1. Paper's not as cheap as you think
Key to Citi's buy thesis is just one prediction: That America's makers of cardboard are preparing to launch an industrywide price hike on "containerboard" (that's cardboard, to you and me).
As StreetInsider.com explains, International Paper and peers such as Sonoco Products (NYSE:SON), Packaging Corp of America (NYSE:PKG), and WestRock (NYSE:WRK) could begin rolling out cardboard price hikes of as much as $40 per ton as early as March 1 of this year, or even Feb. 1. That wouldn't be soon enough to affect Q4 2016 results, or even Q1 2017 results much -- but it would significantly shift the balance of profits for the rest of this year, and years to come.
The $40 price hike, says Citi, should translate into about 3% better-than-expected profits for International Paper in 2017, and 6% more money in 2018 -- predictions that if true, Citi says puts its estimates "solidly above consensus."
2. What is this consensus you speak of?
Here's what S&P Global Market Intelligence has to say on that score: According to the financial data provider, most analysts are looking for International Paper to earn $2.39 this year, $3.92 in 2017, and $4.32 in 2018 -- 81% earnings growth over the course of the next two years. (And remember, Citi is projecting more earnings growth than this, not less).
For comparison, Sonoco is expected to grow earnings 23% between now and 2018, Packaging Corp should grow 30%, and WestRock will reverse the loss it's expected to book for 2016, earn $2.45 in profit in 2017, and then grow that number 22% to earn $3 a share in 2018.
These are all impressive growth rates -- but they don't hold a candle to the profits Citi says International Paper could produce.
3. Is the price right?
Despite having by far the fastest projected earnings growth rate among these four companies over the next couple of years, International Paper boasts the lowest forward price-to-earnings ratio. Assuming estimates for 2017 earnings are correct, finviz.com data pegs International Paper at a 14.4 forward P/E. Packaging Corp is runner up at 16.9, with WestRock trailing at 17.8, and Sonoco bringing up the rear with 19.8.
Granted, farther out, the advantages shift a bit. Using finviz's estimates of long-term growth rates, International Paper is expected to slow down its earnings growth rather dramatically in outlying years, and grow at less than 8%. That would make it only the second-fastest grower, lagging Packaging Corp. Relative to this expectation, investors could be forgiven for worrying whether even 14.4 times earnings is a low enough price to pay for the stock.
Bonus thing: Making sense of high stock prices
And maybe International Paper's price is not low enough. After all, from a PEG analysis standpoint, it makes little sense to pay 14.4 times forward earnings for International Paper based on a short-lived growth spurt, if long term, the stock will grow at less than 8%. And in this regard, Citi explains that it, too, has reservations -- but also a rationalization.
Says Citi: "IP's current trading multiple is elevated relative to its history." But at the same time, the analyst sees a big "discount to the [valuation of the] S&P" 500 index, which according to Morningstar data, is selling for an 18.5 forward P/E.
In other words, Citi agrees that from an objective standpoint, International Paper stock looks expensive -- but then again, most stocks are expensive today. As the analyst sees it, if you can buy International Paper at a high valuation, but one that's nonetheless lower than the valuation of everything else, then that still qualifies as a bargain.
For the record, I don't personally buy that argument. I still think that expensive is expensive, period. But if you want to know why Citigroup is recommending buying International Paper despite it being expensive, well, now you know.