Something interesting happened a few weeks ago. A Dividend Contender cut its dividend. This cut is the first dividend cut by any company that raised the dividend for 10+ years in a while. The last one was when AT&T announced its bid dividend cut, which affected a lot of investors. This cut was primarily due to the spinoff of the Sylvamo (SLVM), IP’s former global printing papers business. Hence, many investors will view this as an adjustment to account for lower earnings and cash flow. However, the company announced a relatively large share repurchase plan of $2 billion. The dollar amount in the plan could have easily covered the dividend cut. In any case, after the dividend cut, International Paper’s streak of dividend increases has ended, and the company is no longer a Dividend Contender.

Overview of International Paper

International Paper traces its history back to 1898, when 17 pulp and paper mills in the northeast merged. Since the mid-1980s, International Paper went through acquisitions that made it a giant for producing paper, paper boards, wood products, beverage packaging, chemicals, and more. Restructuring refocused the company, and today, International Paper is a global company focused on paper and packaging. Pre-spinoff, the company operated through three business segments: Industrial Packaging, Global Cellulose Fibers, and Printing Papers. Major brands (pre- spinoff) include Hammermill, Springhill, Williamsburg, Postmark, Accent, Great White, Chamex, Ballet, Rey, Pol, and Svetocopy. After the spinoff of Sylvamo, the company is primarily a packaging company with a small fluff pulp business (~15% of sales). Total revenue was $20,580 million in 2020 and $21,932 million in the LTM.

Spinoff of Sylvamo

International Paper divested its global paper products business. The new company, Sylvamo, started trading as an independent company on October 1, 2021. International Paper announced the spinoff on December 3, 2020. The main goal was to streamline the company, reduce costs, and accelerate growth.

Specifically, the company stated:

The transaction will be implemented through the distribution of SpinCo shares to International Paper shareowners. International Paper will retain up to 19.99% of the shares of SpinCo at the time of the separation, with the intent to monetize and provide additional proceeds to International Paper.

The proposed spinoff is subject to customary conditions, including final approval by the International Paper Board of Directors, receipt of a tax opinion, and the filing and effectiveness of a Form 10 registration statement with the US Securities and Exchange Commission. No assurance can be given regarding the form that a spinoff transaction may take or the specific terms or timing thereof, or that a spinoff will, in fact occur.

Consistent with International Paper’s longstanding capital allocation policy of paying a competitive and sustainable dividend at 40 to 50% of free cash flow, International Paper expects to reduce its current dividend by 15 to 20% in proportion to the cash generated by SpinCo upon completion of the spinoff. SpinCo is not expected to initially pay a dividend and its dividend policy will be determined by its board of directors following the completion of the transaction.

International Paper expects to maintain a strong balance sheet and remains committed to its current investment grade credit rating with a stable outlook.

The spinoff effectively made International Paper a packaging company with extensive corrugated board operations with a fluff pulp business. The company now has roughly 28 mills (20 containerboard mills and eight pulp mills) and 220 converting facilities. The company also has operations in Europe, the Middle East, and Asia.

Source: International Paper Investor Relations

However, today, the majority of sales are in North America. So, an investment in International Paper is a bet on growth in corrugated packaging in the US and Mexico. International Paper is the market leader in industrial packing and fluff pulp in North America.

Source: International Paper Investor Relations

Sylvamo will have about $4 billion in sales with eight mills and 2.9 million metric tons of annual paper capacity, and 0.4 million tons of coated paperboard capacity.

The spinoff was executed on October 1, 2021. As a result, shareholders received one share of Sylvamo for every 11 shares owned of International Paper stock. Sylvamo is now trading on its own and is in the S&P SmallCap 600.

International Paper’s Dividend Cut

International Paper was a good dividend growth stock for the past decade. The dividend growth rate was about 17.75% CAGR. However, the growth rate slowed in the past 5-years and 3-years to 4.56% CAGR and 3.25% CAGR, respectively, as seen in the chart from Portfolio Insight.*

Source: Portfolio Insight*

International Paper announced the dividend cut in the initial spinoff announcement. The initial information pegged the dividend at 40% to 50% of free cash flow. At the time, management expected the dividend to be reduced by 15% to 20%. The actual dividend cut was lower.

International Paper announced the actual dividend cut on October 12, 2021. The quarterly dividend was cut by 9.8% to $0.4625 per share from $0.51 per share. The forward dividend yield was 3.5% at the time of the cut.

Specifically, the chairman & CEO Mark Sutton commented,

We are committed to a competitive and sustainable dividend of 40% to 50% of free cash flow. The dividend adjustment we are making is consistent with our dividend policy and is well below the 15 to 20% adjustment we anticipated when we announced the spinoff of our printing papers business late last year.

Dividend Safety After the Cut

It is clear the dividend could have been maintained, but it would consume a slightly higher free cash flow. However, International Paper’s CEO clearly wants to conduct share buybacks at a relatively high dollar value. International Paper has about a $19 billion market cap, so a $2 billion share repurchase plan is about 10% of total shares. Notable, this dollar value is in addition to the $1.3 billion remaining on the previous authorization.

The forward annual dividend is now $1.85 per share. The consensus earnings estimate per share in 2021 is $4.26. So, the forward payout ratio is about 43%, which is a reasonably conservative value. It is also lower than my target of 65% or lower.

The dividend is also safe on a free cash flow (FCF) basis. International Paper is targeting a dividend payout of 40% to 50% of FCF. Based on this, we can assume that the dividend is safe. My target value for the dividend-to-FCF ratio is 70% or lower.

International Paper is aggressively reducing debt. The company had a high leverage ratio and low-interest coverage due to acquisitions and restructuring. The leverage ratio was about 4.0X in 2016, with a balance sheet debt of $11.3 billion and $3.4 billion in pension deficits. International Paper has whittled this down to a leverage ratio of 2.9X at the end of 2020 with a balance sheet debt of $8.1 billion and a pensions deficit of $1.1 billion.

Source: International Paper Investor Relations

At the end of Q3 2021, International Paper had $2,122 million in cash and cash equivalents, while the current portion of long-term debt was $221 million and long-term debt was $8,166 million. In addition, the leverage ratio not including the pension gap is approximately 1.94X, and interest coverage is currently around 4X. These values indicate that the dividend is not at risk and safe.

Final Thoughts on International Paper Dividend Cut

International Paper cut its dividend after a spinoff. However, it is not clear if the dividend cut was necessary from a dividend safety perspective. The company has reasonably conservative dividend safety metrics. The cut mostly seems to be driven by management’s desire to conserve free cash flow and allocate capital for share buybacks and deleveraging. My general rule of thumb is to sell a stock if the dividend is cut or suspended. However, International Paper may still be a good income stock based on the current dividend yield and dividend safety.