International Paper: Extreme Restructuring

Exactly four years ago, as the stock market emerged from a long dark period, International Paper traded for $34.80 a share. On March 7, 2007, IP (symbol IP) closed at $34.90. You're not looking at typos. The stock is up a dime over the past four years. And there wasn't much up-and-down action for traders to exploit, either. The more things changed in the market, the more they stood motionless for investors in IP.

Despite the expanding economy, paper is a tough business. Weak demand and wide substitution of cheaper grades hurts, as well as pressure from e-mail and online publishing. Orders for newsprint (not one of IP's businesses) are sinking. Plus, rising energy costs clobber this industry. No wonder many of the stocks in the paper and forest-products sector appear both cheaply valued and deeply out of favor, says manager Peter Langerman of the bargain-hunting Mutual Shares fund.

Yet IP is on his list of buys, and if you look closely, you might add it to yours. Since 2005, and more frequently in the past few months, IP has sold or put up for sale a list of what it considers either lousy businesses or distractions, such as chemicals, kraft paper (the stuff of grocery bags), plywood and lumber, and forest land, among others. Some have gone to competitors and some to private-equity investors.

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The result: $10 billion in cash, which IP is using to retire debt, buy back shares, shore up the pension fund, and invest overseas. Business is strong at the remaining operations -- uncoated free sheet paper, one type of which is used in computer printers, and all sorts of boxes and cardboard packaging, from coffee cups to industrial-shipping boxes.

IP is essentially betting that simple is better. It hopes that investors will find it more attractive and easier to understand as a smaller company with a healthy cash position rather than an unwieldy giant with the burden of being the world's largest paper and forest-products company.

IP stock isn't easy to evaluate because the company is changing so radically. Ignore the full reported fourth-quarter profit number. Much of it came from proceeds of selling assets. If you consider what Standard & Poor's calls core operating earnings (from continuing businesses), IP still sells at 26 times the past 12 months' profits -- way too much for a company with low-margin operations and so many uncertainties, from the cost of electricity to a growing number of operations in such emerging nations as Brazil, Russia and China. But improved profit margins at the remaining businesses, cost and debt reductions, and better management that is able to focus on fewer businesses should help boost profits. SP thinks that IP can earn $2.15 per share from operations in 2007. That would be a more reasonable P/E of 16, a good price for a stock that also yields an above-average 3%. IP hasn't raised dividends since 1995, but it hasn't cut them, either.

Corporate makeovers don't always do much for ordinary shareholders, but here's a case where the old plan -- or lack of planning -- was shaky. The new International Paper sounds like a better version.