Mercer International Inc. (NASDAQ:MERC) Q4 2022 Earnings Call Transcript

Mercer International Inc. (NASDAQ:MERC) Q4 2022 Earnings Call Transcript February 17, 2023

Company Representatives: Juan Carlos Bueno – President, Chief Executive Officer David Ure – Senior Vice President, Finance, Chief Financial Officer and Secretary

Operator: Good morning and welcome to Mercer International’s, Fourth Quarter 2022 Earnings Conference Call. On the call today is Juan Carlos Bueno, President and Chief Executive Officer of Mercer International with David Ure, Senior Vice President, Finance, Chief Financial Officer and Secretary. I will now hand the call over to David Ure. Thank you.

David Ure: Good morning, everyone. Thanks for joining us today. I will begin by touching on the financial and operating highlights of the fourth quarter, before returning the call to Juan Carlos to provide further color on the markets, our capital plan as well as our strategic initiatives. Also, for those of you that have joined today’s call by telephone, there is a presentation material that we’ve attached to the Investor section of our website. But before turning to our results, I’d like to remind you that in this morning’s conference call, we will make forward-looking statements. And according to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, I’d like to call your attention to the risks related to these statements, which are more fully described in our press release and in the company’s filings with the Securities and Exchange Commission.

This quarter we achieved EBITDA of approximately $96 million compared to Q3 EBITDA of roughly $141 million. This solid Q4 results was a consequence of improved pulp production of our Stendal mill, as we return the mill to near full production after the Q3 wood yard fire, along with higher pulp and energy sales volumes. This was more than offset by lower energy sales realizations in Europe due to the recently implemented energy price cap, along with considerably higher pulp fiber and chemical costs. In the 2022 fiscal year, we achieved record EBITDA of almost $537 million, driven by strong pricing for our products through most of 2022, a relatively strong U.S. dollar compared to the Euro and Canadian dollar, along with improved pulp sales volumes.

Currently, Stendal is approaching 100% of capacity, and we expect the final repairs to the fire damaged wood yard infrastructure to be complete in Q2. The loss is covered by our insurance program, and we expect it to be settled later in 2023 once permanent repairs are complete. As of today, we have received advance payments from our insurer totaling roughly $18 million. After giving consideration to our planned 21 day shut of Stendal in November, our mills ran well this quarter when compared to Q3 when we had 17 days of scheduled maintenance at our Rosenthal mill. Our pulp segment contributed quarterly EBITDA of roughly $98 million and our solid wood segment, which includes our Friesau lumber operation, along with the newly acquired Torgau mill and our Spokane mass timber startup contributed quarterly EBITDA of about $5 million.

You can find additional segment disclosures in our Form 10-K which can be found on our website and that of the SEC. Supply constraints from Western Canadian producers, coupled with the increased demand from China helped keep Q4 pricing relatively stable in our markets, with only pricing declines. European NBSK list prices averaged $1,442 per ton in the current quarter, compared to 1,500 per ton in Q3. In China, the Q4 average NBSK net price was $920 per ton, down $49 from Q3. The price gap between NBSK and hardwood narrowed slightly in the quarter due to hardwood prices decreasing less than NBSK prices, with the average Q4 net eucalyptus hardwood price in China at $837 per ton, down $18 from Q3. In total, average pulp sales realization movements negatively impacted EBITDA by almost $7 million compared to the prior quarter.

Overall, our average lumber realizations fell sharply in Q4 due to relative weakness in both the U.S. and European markets. The Random Lengths U.S. benchmark for Western SPF 2 and Better average $410 per 1,000 board feet in Q4, which was down $170 from last quarter. Our average European sales realizations were down approximately $118 per thousand compared to Q3. Today, the benchmark lumber price in the U.S. is currently $455 per 1,000 board feet. Our electricity sales reflect our strong generation, along with elevated prices in Europe, where Q4 prices were in the range of $200 per megawatt hour. Exports to the grid totaled about 222 gigawatt hours in the quarter, which was up relative to Q3, principally the result of Stendal’s return to near full production and the addition of Torgau.

The energy situation in Europe changed significantly in the quarter. The December implementation of an energy price cap effectively reduced the net realized price to about $120 per megawatt hour, which while lower than Q3 remains much higher than our historical realizations prior to 2022. Q4 reflects a full quarter of results from the Q3 acquisition of the Torgau mill. However, the net earnings impact was nascent this quarter due to its GAAP requirement to mark-to-market acquired inventories and order books, in this case for pellets and pallets to the current market price; a treatment that removes most of the margin from the first full quarter of owner. While shipping palette and heating pellet prices are currently somewhat depressed, we expect a modest contribution to earnings from Torgau in Q1.

We reported consolidated net income of almost $20 million for the quarter or $0.30 per basic share, compared to net income of $67 million or $1.01 per basic share in Q3. For the full year we are reporting record consolidated net income of $247 million or $3.74 per basic share. We consumed about $8 million of cash in the quarter compared to Q3 cash generation, which totaled about $27 million after adjusting for the acquisition of the Torgau sawmill and the related draw on our German revolving green credit facility in Q3. The reduction in cash generation is due to lower EBITDA, along with working capital movements reflect higher inventories. Capital spending in the quarter was about $50 million and totaled $179 million for the full year. Looking ahead to 2023, we are targeting CapEx of about $175 million to $200 million in our operations this year.

Juan Carlos will add more color on our CapEx program in a moment. At the end of the quarter our liquidity position increased slightly from Q3 and totaled about $636 million, comprised of $354 million and $282 million of undrawn revolvers, including our new $300 million Euro sustainability linked facility. Our quarter end liquidity position was up about $15 million from the previous quarter due to increased availability on our credit facilities. And as you would have noticed from our press release, our board has approved a quarterly dividend of $0.075 per share for shareholders of record on March 29, 2023, for which payment will be made on April 5, 2023. That ends my overview of the financial results, and I’ll now turn the call to Juan Carlos.

Juan Carlos Bueno: Thanks Dave. Overall, I’m pleased with our fourth quarter operating results, as it provided a solid conclusion to a record year for our company. Operationally we ran well, and our production and sales volume were up for all our products compared to Q3 and we return our Stendal mill to almost full capacity midway through the quarter. As we expected the pulp markets weakened, but only slightly. Lumber markets weakened more significantly in the quarter, but we are beginning to see signs that this market will improve. As Dave highlighted, there were significant changes in energy policy in Germany during the quarter, which reduced our electricity revenue compared to Q3, but while this top line reduction can quickly lower costs for natural gas, chemicals and pulpwood are now following and will materialize in our results in the next few quarters.

We made good progress with the integration of the Torgau sawmill, coordinating the logistics for the various fiber and wood transfers we envisioned takes time, and I am excited with our progress to date with regards to our targeted synergies. On an annualized basis, we achieved approximately $6 million of synergies in Q4 and once we fully are integrated, we expect to achieve about $60 million per year of synergies. I’m also pleased with the progress we’re making in developing our mass timber business. Our design and engineering teams are now actively bidding on numerous mass timber products, and we have currently over 50 projects in various stages of evaluation or bid, and many of our complex projects will take time to negotiate and finalize, but we expect a few of these already to be contracted in the coming days and weeks.

As I mentioned, global pulp markets remained resilient through the fourth quarter with prices down only slightly. There are a number of factors currently in the NBSK space, including some softness in demand in Europe related to weakness in economic conditions brought on by the energy crisis there. At the same time, we’re seeing considerable demand improvement from China as COVID restrictions wane, and shipping channels reopen. Then of course in recent months, reduced supply is now beginning to have a material impact as paper producers look to increase their pulp inventories. So the NBSK market has seen the equivalent of two pulp mills permanently removed between 2022 and early ’23. And in addition, temporary curtailments driven by fiber supply constraints in western Canada are also impacting the market.

This includes our Cariboo joint venture, where we’re taking two months of downtime this spring and summer due to the lack of fiber. Hardwood prices also held their own in the quarter, although we are expecting some softness in the next few quarters as significant new capacity comes online in ’23, which may be detrimental to this market. It will take some time for the market to digest these volumes, and we expect the hardwood, softwood price gap could expand over time. The fourth quarter lumber market pricing reflected weakening of both the U.S. and European markets. On average, our lumber realizations were down in Q4 to 25% from Q3. The negative market sentiment is principally the result of uncertainty created by rising mortgage rates and weak economic indicators.

The U.S. market continues to be volatile, but we’re seeing some positive momentum, and despite the volatility today, we believe the midterm backdrop for U.S. lumber pricing condition remains positive, with low lumber channel inventories as we approach the spring construction season. The large number of sawmill curtailments, relatively low housing stock and constructive homeowner demographics, putting positive pressure on the supply/ demand fundamentals of this market. We will continue to watch and to match our mix of lumber products and customers to current market conditions. In Q4, 32% of our lumber sales volumes were in the U.S. market. The majority of the remainder of our sales were in the European market. Also, you know we saw our logistic channels continuing to improve, which resulted in a modest decrease in our freight costs.

High fuel costs are keeping freight costs higher than what we hoped for, but the improvements allows us to be more cost effective like reducing our reliance on higher cost trucking solution. In Q4, we saw pulpwood prices peak before reducing partway through the quarter. The high pulpwood costs were mainly driven by demand from the energy sector as users were looking for cheaper forms of energy. Looking ahead to Q1, we are anticipating downward pulpwood pricing pressure in Europe. While European sawlog demand and supply are in balance and as a result we expect sawlog pricing to modestly decrease in Q1. Now in Western Canada, decreased log harvesting levels and related sawmill curtailments are putting upward pressure on pulpwood prices. Not surprisingly, these factors are also impacting fiber supplies.

And as mentioned, our Cariboo joint venture pulp mill has announced our curtailment due to lack of fiber, and we have also seen fiber concerns driving the recent announcement of the permanent closure of another interior BC pulp mill. In 2022 we invested almost $180 million in our operations, the majority of this going into higher return projects like our Celgar and Peace River. These projects would generate high returns in the form of lower wood costs and have considerable carbon reduction attributes, which will help us achieve our carbon reduction goals. Looking to 2023, we expect to invest between $175 million and $200 million in our mills as Dave had mentioned before, and we will again be investing heavily in high return projects. This will include the Lignin Development Center and extraction pilot plant and the $27 million expansion project our Spokane mass timber plant.

This Spokane plant investments will allow this state of the art facility to fully utilize our more varied raw material mix, add glulam to our product portfolio and increase finger joint production. This is a first step in what will ultimately be an expansion of CLT capacity in anticipation of our efforts to steadily increase our order book for mass timber products. As we think about climate change and the rapid shift occurring regarding reducing carbon emissions, products like lignin, mass timber, green energy, extractors, lumber and pulp are all products that will play increasingly important roles in displacing carbon intensive products. Products like concrete and steel for construction, plastic packaging, fossil fuel generated electricity and synthetic fragrances and flavors, even synthetic textiles.

We are committed to our 2030 carbon reduction targets and believe our products form part of the climate change solution. In fact, we believe that in the fullness of time demand for low carbon products will dramatically increase as the world looks for solutions to reduce its carbon emissions. To that end, going forward, you will see us looking to grow these areas of our business. We remain bullish on the long term value of pulp, but to bring more balance to our business, solid wood and extractors will go more quickly. Also, to remind listeners, we remain committed to our carbon emission reduction targets. I encourage you to look at our website for more details, and we’re soaked in our ability to meet these targets that we converted our German revolving credit facility to a sustainability linked loan, making us part of a small group of wood product producers willing to invest in carbon emission reduction targets in favor of modest reductions in our cost of borrowing.

So, that’s it. Thanks for listening, and I will now turn the call back to Sarah for questions. Thank you.

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Q&A Session

Operator: . The first question comes from the line of Kasia Kopytek from TD Securities. Please go ahead.

Kasia Kopytek: Hi, good morning! Apologies in advance. I think I have a bad connection. David, you mentioned $18 million in insurance proceeds to-date, how much was in Q4?

David Ure: Yeah, it was about $6 Kasia.

Kasia Kopytek: Okay, so most of it had been revived in Q3 then I take it.

David Ure: Yeah, that’s right. That’s right, so there’ll be a little bit coming, but the insurance here has actually been quite efficient. So the insurers been providing us advances that sort of match our expenditures. So it’s generally been coming in as the work has been done.

Kasia Kopytek: Got it. So maybe just a single digit few million coming in Q1, is that fair?

David Ure: I think that’s fair, yeah.

Kasia Kopytek: Great! And David, can you quantify the mark-to-market on the inventory? How much that impacted the EBITDA in the quarter.

David Ure: Yeah, roughly $10 million.

Kasia Kopytek: And the Q4 depreciation rate, is that a good rate to use going forward as a run rate for modeling purposes.

David Ure: Yeah, that should be, that should be all right.

Kasia Kopytek: And then, David, if you could just give a maintenance outlook for 2023. I know it’s in your 10-K, but if you could specify between the mills that would be great.

David Ure: Sure, just one moment here. All right, okay, so in Q1 we will have the shut at Celgar, a small shut at Celgar. In Q2 we will have a larger shut, so a fairly substantial typical shut. Peace River for a couple of weeks. We also have a shut at Cariboo in Q2. Q3 we will have our typical two week shut at Rosenthal, and Celgar will have their major shut in Q4, sort of a two to three week shut in Q4.

Kasia Kopytek: Thanks, Dave. What do you think for paper maker demand right now? And what are your order books looking like?

Juan Carlos Bueno: It’s Juan. Kasia, thanks for the question. In paper demand, what we’re seeing is obviously a slowdown in Europe, in the European markets. Those have been the one that have suffered a bit the most since I would say almost end of Q3 and beginning of Q4. But now what we see compensating that is obviously the China coming back. So there’s a little bit of a balance there in terms of how the paper market is moving.

Kasia Kopytek: Thanks for that context. So the last one for me, you had Torgau for a little over a quarter. How is that going relative to your expectations and any contacts you could provide there, any way on progress to-date?

Juan Carlos Bueno: Very good and very happy about the progress in Torgau, particularly with the synergies that we’re already able to extract in very little time. When we think about this, we just took over, 1st of October. And looking at the progress that we made, moving all sorts of products around our mills in Germany, has been very, very – and as we unlock further capacity of Torgau, we expect those synergies just to increase. What we’re aiming for obviously is to increase our lumber production over there, but at the same time we have benefits when it comes to the movement of wood chips or the movement of pines, sawdust and whatnot. So it’s a very positive addition to our overall portfolio.

Kasia Kopytek: Thanks very much, everyone. I appreciate the context. I will get back in the queue.

Juan Carlos Bueno: Thank you.

Operator: Your next question comes from the line of Paul Quinn from RBC Capital Markets. Please go ahead.

Paul Quinn: Yeah, thanks very much and good morning, guys. I guess maybe this is for David. By David, if you could just give me a rough cost of the shut at Torgau and Celgar, how should we model that in?

David Ure: For 2023, Paul?

Paul Quinn: Yes, just the sort of fiber related shuts that you’re taking in both mills.

David Ure: Okay, so not the maintenance shuts. You’re talking about the curtailments?

Paul Quinn: Right, yeah.

David Ure: Yes, I don’t think we have. I don’t think we have €“ I don’t think we can disclose that. But I can tell you that the reason you do it is because that incremental fiber that is available to operate the mill is higher than what it would take to just to cover your fixed cost. So generally that’s the call we make.

Paul Quinn: Okay, and just. Yes, you don’t have the specifics, but what about overall fiber costs in general? I mean, you’re obviously seeing a big price increase in Europe, but I suspect that’s also affecting you in BC, Alberta, pretty flat?

Juan Carlos Bueno: Yes, Alberta €“ Paul, this is Juan. Alberta is €“ we have seen a bit of increase, but nothing too dramatic. Remember in Alberta two mills that we work with, we have quite a significant amount of wood at our disposal. So it’s a very different situation from what we experienced in British Columbia. Now having said that, obviously also in Germany we had over the quarter of a very high increase in wood costs associated with all the energy crisis and all the scare that was going on during that period of time. But obviously that has now eased down significantly, and actually what we’re seeing today is an important reduction of the cost of the wood chips in Germany, which obviously is very, very favorable to us.

Not yet to the level that we would want it to be, but clearly heading in the right direction, and we expect that to continue going forward, so I think that’s very positive overall. And in the case of BC, obviously with the curtailments of €“ continuous curtailments of saw mills, that is putting a significant strain in the whole system. And we’ll see now that this other pulp mill has been shut down as was announced recently. Obviously that creates a little bit more balance, but yet we have to see how the development goes for the coming months.

Paul Quinn: Okay. And then just longer term on fiber availability, especially in BC, because it seems most constrained there. What do you think of the positioning of the mills that you’ve got in that jurisdiction? Are they going to be able to – you know, be able to be fibered up going €œforward€ or is it going to be rolling downtimes because of the lack of residuals?

Juan Carlos Bueno: There’s a €“ if I talk about Celgar specifically, there’s a couple of things that makes Celgar probably in a stronger position than other pulp mills that are in BC, and it’s geographic location since we’re close to the U.S. border. We have the advantage of being able to tap into the U.S. market for chips. We’re actively pursuing that and now basically setting up the proper logistics that would allow us to flow, to have a good flow of chips from the U.S., in case the BC continues to put more and more pressure on this. So that way we can protect ourselves from further issues in British Columbia. I think that’s something very positive for Celgar, number one. And number two, we have the woodroom, that is €“ that we’ve announced and that will be ready, not only in Peace River, but also in Celgar later in the year.

We expect that woodroom to be up and running by the end of the year. And the fact that we are able to bring that woodroom in play, that basically reduces the dependence that we have on sawmill residuals. So that’s another very important step to make sure that Celgar runs without interruptions once those things are in place. In Cariboo it’s a little bit different situation. We don’t have those options of the woodroom or the proximity to the U.S., but together with our partners, we’re working very diligently in making sure that we secure the necessary wood that is required for the mill. And we’ll see how the development of this year works, but we’re actively pursuing options to see if we can reduce the 60 day short curtailments that we’ve announced before.

So we are in the works on that.

Paul Quinn: All right. David maybe over to you. Just that $175 million or $200 million in CapEx, how do you split that between maintenance and then the amount that you’re spending on high return projects?

David Ure: Yes, that’s always a tricky one, because one person’s definition of MOB might be different than anothers. But it’s probably a pretty good mix of €“ it’s probably close to 50-50. So it’s got some terrific projects like Juan Carlos had mentioned. This will be the year that we do the bulk of the work on the Spokane CLT plant, so we’re looking for some expansion there. We’re also doing some work at Torgau, some early optimization work to increase the lumber production at Torgau, and of course these – the woodroom that Juan Carlos talked about at Celgar. We’re also doing the same thing at Peace River, which is nearing completion, and both of these projects are extremely high, high return. But I would say it’s probably roughly 50-50.

Paul Quinn: Okay and just lastly, and I didn’t – sorry, I haven’t been on these calls for a while just due to conflicts, but paper excellence is close to – from their acquisition resolute, resolute effort to best, both or any interest in those.