Mercer International's CEO Discusses Q1 2014 Results - Earnings Call Transcript

May. 2.14 | About: Mercer International (MERC)

Mercer International Inc. (NASDAQ:MERC)

Q1 2014 Earnings Conference Call

May 2, 2014 10:00 AM ET

Executives

David M. Gandossi – Executive Vice-President, Chief Financial Officer and Secretary Relations

Jimmy S.H. Lee – Chairman, Chief Executive Officer and President

Analysts

Paul C. Quinn – RBC Dominion Securities, Inc.

Andrew M. Kuske – Credit Suisse

Andrew E. Shapiro – Lawndale Capital Management LLC

David Quezada – Raymond James Ltd.

Operator

Good morning and welcome to Mercer International’s First Quarter 2014 Earnings Conference Call. On the call today is Jimmy Lee, President and Chief Executive Officer of Mercer International; and David Gandossi, Executive Vice President, Chief Financial Officer and Secretary.

I will now hand the call over to David Gandossi.

David M. Gandossi

Thanks, Aaron. Good morning everyone. As usual, we will begin with formal remarks, after which we will be happy to take your questions. Please note that in this morning’s conference call, we will make forward-looking statements 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 with the company’s filings with the Securities and Exchange Commission.

I’d first like to begin by reminding everyone that effective October 1, 2013, we have changed our reporting currency from the Euro to the U.S. dollar. Our historical financial information and our quarterly report on Form 10-Q, our annual report on Form 10-K and our earnings press release has been translated to reflect this change, as if it had been previously reported in U.S. dollars. As a result, all monetary references in today’s call will be in U.S. dollars, unless otherwise noted.

I’ll now cover some of the key financial aspects of the quarter, and then I’ll pass the call over to Jimmy.

In Q1, we achieved $59 million and increase of almost $32 million relative to the fourth quarter. In Q1 pulp pricing was up and solid demand across all markets led to higher sales volumes. Pulp list prices rose in the quarter to $925 per ton in Europe and $760 per ton in China as of the end of Q1.

On average list prices were up close to $20 per ton in both the markets. Also positively affecting EBITDA this quarter were the impact of favorable foreign exchange movements on our Canadian dollar cost and lower SG&A cost. In addition, not having a major maintenance and no restructuring costs in the quarter further contributed to the higher EBITDA compared to the quarter four.

Overall our mill set a new quarterly pulp production record in Q1 led by Stendal, who are benefiting from the recently completed Blue Mill project coupled with solid production at both Celgar and Rosenthal. Our finished good inventory volumes were essentially flat and strong sales pace with the record production.

We reported net income of $21 million for the quarter were $0.38 per basic share compared to a net loss of $9.8 million or a loss of $0.18 per basic share in Q4. Our Q1 2014 net income includes a non-cash unrealized gain of approximately $3.2 million on the mark-to-market valuation of our fixed interest rate swap.

The U.S. GAAP IFRS differences relating to major maintenance did not have any impact this quarter, when comparing our EBITDA to those at many of our competitors because we did not have the major maintenance shut in Q1.

Switching to cash flow, our consolidated cash position was up approximately $24 million compared to Q4 sitting at over $172 million. Quarterly working capital movements increased cash by almost $18 million on a net basis, primarily due to an increase in accounts payable and a decrease in inventories partially offset by an increase in accounts receivables.

Capital expenditures including intangible asset expenditures grew approximately $8.3 million during the quarter of this total roughly $4.4 million was spent at Stendal, the majority of which comprise final payments on Stendal’s Blue Mill project. In addition, $1.7 million was spent on the development of our new enterprise wide software system, while the remainder was spent on high return capital projects at Rosenthal and Celgar.

On the financial side, Stendal made the schedule principle payments on its Stendal and Blue Mill facilities totaling approximately $30 million. And Rosenthal made the final payment on its investment term loan. As at the end of the first quarter Stendal had received a total of approximately €8.8 million of the €11 million worth of government grants, it is eligible for regarding the Blue Mill project. The outstanding government grant balance is expected to be received by the end of the Q2.

Our working capital on the 12-month period ended March 31 excluding cash and short-term debt increased by approximately $12 million to $201 million. The increase was primarily due to higher inventories and prepaid expenses and lower payables. In terms of liquidity at March 31, we had approximately €28.4 million of undrawn revolvers available at Rosenthal and approximately C$38.3 million available at Celgar.

Our $172 million of cash at the end of Q1 is comprised of approximately $108 million for the Restricted Group and about $64 million at Stendal. Net debt to equity on a consolidated basis at March 31 is down slightly from Q4 at approximately 2.1 times equity, while the Restricted Group’s net debt to equity was also down slightly at less than 0.6 times equity.

In July 2013, we announced a workforce reduction at the Celgar mill. At March 31, 2014 this process is on target with no significant cost incurred in Q1 and we continue to expect this workforce reduction will realize pretax savings between $8 million and $10 million annually with about 80% of those annual savings being realized this year. I would also like to provide a quick update on our project to implement a new enterprise resource planning or ERP solution.

As I noted in Q4, we have selected SAP as it best meets our current needs and is flexible enough to meet our needs going forward as our business evolves. This project is going as planned and is on target to be completed in stages over the next two years. One final point on April 2, we closed down an equity offering and issued $8.05 million new common shares, which included the underwriters full option of $1.05 million common shares.

The shares were offer to the public at a price of $7.15 per share with the net proceeds from this offering totaling approximately $53.6 million. This offering was a strategic initiative to ensure Stendal mill has strong financial flexibility and to also allow us to perceive with certain targeted high return capital projects. Due to the timing of this transaction will be counted for Q2. And that ends the – my overview of the financial results.

So I will now turn the call over to Jimmy.

Jimmy S.H. Lee

Thanks David. Good morning everyone. Let me start by saying we are very pleased with our first quarter results compared to Q4. Pulp prices were up and our sales volumes increased significantly. The success of our Blue Mill project is also reflected in our results as Stendal strong production led the way in achieving record pulp production and record electricity sales volumes.

In the first quarter, steady demand pushed average NBSK list prices up across all markets. In Europe, the quarterly average list price rose to $920 per ton, while the Chinese quarterly average list price were up to $753 per ton.

In March, NBSK produced inventories were at 28 days, down one day from February. At these inventory levels, the NBSK market is considered to be imbalance.

It is worth noting that inventory levels came down despite the logistical issue facing certain Canadian producers, which limited sales and force producers to build finished good inventory. Specifically extreme winter conditions in North America, which created unreliable railcar availability through the winter, while currently Canadian railcars mandated priority for grain shipments continues to see really limit railcar availability for pulp shipments.

And in February, container truck drivers went on strike at the port of Vancouver, which effectively stop all pulp shipments through the port from most of Q1. The truckers are now back at work, but the cargo backlog will take weeks to unwind. Not surprisingly given the new capacity that is coming online, the March hardwood pulp inventories are up three days from February at 48 days.

I will speak a little bit more about this in a moment. NBSK list prices in April are $130 in North America, $925 in Europe, and $750 in China. We believe that despite the slightly lower April prices in China that low customer inventories will force buyers back into the market in late Q2 or early Q3, which should create upward pricing pressure.

Adding to the – expect the pricing pressure is the fact that NBSK production will start to slowdown as mills begin to take their annual maintenance shuts. And in Europe supply will be further reduced in the short-term as recoverable issue at an Austrian NBSK mill forces it to curtail production.

Overall we do not expect prices to drop significantly in Q2. In addition, when thinking about the demand for NBSK, it is worth noting that there are approximately 3 million tons of incremental tissue capacity coming online globally in 2014 with approximately 1.8 million tons coming online in China.

In addition, there are approximately $1.3 million more tons of tissue capacity scheduled to come online in 2015. This growth in tissue capacity is unprecedented and it is expected to further tighten the NBSK market. As a result we continue to be optimistic about the demands for NBSK. With regard to the approximately 1.6 million tons of new hardwood capacity coming online in 2014, certain analyst expect it will create a drag on the NBSK market. We do not share this view and we believe that the papermaker's ability to substitute hardwood for softwood is limited due to the fact that modern paper machines require certain strength characteristics from the raw materials in order for the machines to run at the high speeds that they are designed for.

However, it is clear that certain customers are expecting NBSK prices to fall with some analyst predicting Chinese pricing as low as $700 per ton. We believe that the lower April pricing in China to be the result of this market psychology, but we expect that this will be shortlist given the current NBSK supply situation. Including that we were seeing fewer tons of NBSK being shipped to China from Europe due to the strong European demand. Consequently we don’t believe that a large price gap between hardwood and softwood will be significantly negative it will have a significant negative impact on NBSK pricing in the near future.

Turning to our pulp production for a moment, Q1 was a record production quarter for us. Stendal achieved its second-best quarterly production, while Rosenthal had another strong production quarter, and despite some unplanned downtime Stendal also had solid production. In total we produced approximately 382,000 tons of pulp this quarter compared to approximately 365,000 tons in the fourth quarter and approximately 361,000 tons in the first quarter of 2013.

Our Q1 production was broken down as follows, Stendal produced 171,000 tons, Celgar produced 119,000 tons, and Rosenthal produced 92,000 tons.

In addition, the mills produced approximately 466 gigawatt hours of electricity in the quarter, compared to 436 in Q4, and 424 gigawatt hours in Q1 of 2013. Our pulp sales volumes were up in Q1 and totaled approximately 301,000 tons compared to 359,000 tons in the fourth quarter and 357,000 tons in Q1 of 2013.

I would also like to highlight the Celgar’s Q1 sales were about 21,000 tons lower than expected due to the railcar and pulp related logistical issue I mentioned earlier.

The sales by mill in the quarter were as follows, Stendal sold 188,000 tons, Celgar sold 98,000 tons, and Rosenthal sold 95,000 tons. While our Q1 sales by region were Europe 219,000 tons, China 114,000 tons, and all other regions combined were 48,000 tons.

Now let me take a moment to discuss developments in the wood market relative to the fourth quarter. Our per ton German fiber cost were down in Q1. Throughout 2013, a number of factors contributed to create several of the higher fiber costs we have seen – ever seen in Europe, made in Q4 2013 and through Q1 the fiber market dynamics began to change.

On unusually warm winter allows for steady harvesting rates and in addition sawmills continue to run at high rates. Which has increased the supply of chips, on the demand side the warm weather has significantly decreased the demand for wood pellets and in turn the pellet producer’s demand for chips.

Overall, we have seen our German fiber costs come down and we expect further decreases in Q2. We continue to monitor closely and are very focused on opportunities to reduce our German fiber costs going forward. In British Columbia, our per ton fiber costs were essentially flat in the first quarter relative to Q4, primarily due to continued strong sawmilling activity in Celgar's fiber basket.

We anticipate that Celgar's fiber cost was relatively flat through the second quarter. We are currently satisfied with each mill fiber inventories and expect it will be able to continue to source the fiber we need.

We regularly get questions about the timing of our annual major maintenance shuts, so I'd like to highlight that our 2014 shuts are scheduled as follows. Celgar, will be down in Q2 for 10 days or approximately 14,000 tons, Rosenthal will be down for 12 days in Q3, or approximately 12,000 tons; and Stendal is not scheduled to have a major maintenance shut in 2014. But instead, we’ll have two small two-day shuts in Q2 and Q4, of approximately 3,600 tons each.

As David mentioned, we issued roughly 8 million new common shares in early April. We are very pleased with the demand for our common shares and the fact that we have a number of new shareholders as a result. We believe that this will increase the liquidity of Mercer’s shares. With respect to our NAFTA claim, we are working with our advisors to move this process forward, and we continue to expect our case to be heard in the mid to late 2014, with a decisions several months after that. We will provide regular updates, as we move through this process.

In closing, there is pressure on the market price concession due to the current supply of hardwood and the widening price gap between hardwood and NBSK. However, we believe that the market fundamentals will reverse that pressure late in Q2 or early Q3 statistically speaking the market is in balance based on the producer inventory levels. In addition customer inventory levels are low and demand in the form of new tissue capacity is expected to grow to 2014 and 2015.

Consequently, we currently feel pricing momentum will begin to build late in the second quarter and we remain confident that the new hardwood capacity will not have a significant negative impact on the NBSK pricing. We continued to be optimistic about the medium to long-term NBSK supply demand fundamentals, which we foresee as being driven by increased economic standards globally.

That is the conclusion of my prepared remarks, and I will turn the call back to the operator. So we can open the call questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Paul Quinn, RBC Capital Markets. Please go ahead.

Paul C. Quinn – RBC Dominion Securities, Inc.

Yes, thanks very much, good morning. Just a question on, you referenced the March stats that show softwood in balance yet we're seeing, I would say, the start of some price weakness in China. How do you reconcile those two, and what do you expect China for the balance in Q2.

Jimmy S.H. Lee

If you look at the situation clearly we believe that the weakness in prices driven by more psychology than anything else. I think everybody's stock in the market down clearly of course from the buyers perspective in China, they are hesitant to buy because everybody is telling them prices will come off. And playing into the situation clearly is the fact that certain not necessarily NBSK producers, but also the Russian as you know NBSK producers because of whatever reason logistical issues as you know as well as other reasons have announced significant price decreases.

There's been others which are followed as a result. But I think if you look at the European and North American situation clearly prices have held up relatively. Well, and at the same time we know that the customer inventory levels certainly from what I can gather, seems to be pretty much at the lower end. We know in terms of our own production inventory levels side from the Celgar situation because of the port and others which of course everyone is quite familiar, certainly in terms of our German operations the inventory levels are very low. Compared to any other kind of similar type of quarters going into the early part of this year. So I think this is not because this is really I would say it’s a psychological driven price weakness more than anything rather than and absolute pure demand or supply, Paul.

Paul C. Quinn – RBC Dominion Securities, Inc.

Okay and then just earlier this week we heard from International Paper regarding their Ilim operation in Brask, and they were describing the startup of that machine as challenging which - but it seems to have been gaining traction and operating rates are 70% and they expect to get that back fully operating by the end of the year. Do you think that have an effect on the market at all?

Jimmy S.H. Lee

No, I think that basically the incremental increase in their production coupled with the fact that of course you're getting new capacity being started up particularly and the tissue area will support really that incremental tons coming into the market. So we’re pretty confident that increase in supply will not really have a big impact.

Paul C. Quinn – RBC Dominion Securities, Inc.

Okay and just lastly a comment I welcome your difference of opinion with just about every other company out there that seems to be very cautious on price, and I'm definitely cautious on price going forward, but - so it sounds like your view is additional hardwood capacity is not going to effect softwood pricing. I'm hoping you are right so best of luck in the quarter.

Jimmy S.H. Lee

Thanks Paul.

Operator

Your next question comes from the line of Andrew Kuske from Credit Suisse. Please go ahead.

Andrew M. Kuske – Credit Suisse

Thank you, good morning I guess questions for Jimmy. And it’s just if you could just give us some perspective on your thoughts and your feelings about the cycle currently, and how it feels, say, versus past cycles. Are we at a point where you feel like you're going to do more mid-cycle numbers or were you trending towards more of a peak cycle? Because the prices would really imply something more on a peak basis?

Jimmy S.H. Lee

Yes, but I mean if you look at the pricing from a European perspective really from a Euro, it certainly not at peak prices, so yes in dollar terms yes certainly it is near to what historic peak pricing has been. But at the same time underlying that of course is the significant increase in discounts which really do not reflect the existing mill that presently the producers are getting.

The other fact I think is a little bit different in terms of this cycle that people are not maybe focusing on is the fact that this probably is the first cycle that I’ve seen were pretty much all the mills have run right through. I’m talking about the marginal mills that typically have taken market related downtime, this cycle they did not. And that’s because they have been owned by different group and it’s a significant amount of tons, which of course continue to run through the cycle. And considering that these have been running inventory levels at the producer side has continued to be drawn down. And if you look at the impacts of the ports strike on the railcar situation even I was expecting that inventory levels would actually build because of that, but surprisingly that was actually an inventory drop.

That is a very positive development in my mind and it clearly shows the demand side is strong and supply is limited. Now unlike past cycles when prices are been high, what you always have is these marginal mills which are taking curtailments all of a sudden starting to come back into the market. And therefore forcing the cycle again to drop and we go back to the cyclical situation that industry as typically been accustomed to.

Now we don’t know what the impact of really the non-closures of these marginal mills at this cycle will mean in terms of the shape of the cycle this time around. My expectation is that you got pretty much everybody running, who is able to run – running, inventory levels are pretty good. There is no new capacity or marketable capacity that I’m aware of which will suddenly come back to hit the market. And so I’m expecting this is a gradual recovery, prices continuing to improve and new customers and new capacity certainly will continue to produce that incremental demand growth that should pick up a flak in the system. And that’s why I am optimistic, I don’t see quite the reasons why some of I guess my peers in the industry are taking a different view, but as I said like market physiology can be a very strong influence and how people could see things.

Andrew M. Kuske – Credit Suisse

So that’s very helpful. Just a follow-up on a couple of your points, you given the operating rates where they are in the high 90s on the softwood side, and really the tightness in the market and some fourth quartile facilities that are operating pretty much flat at the stores we can see. What do you think your cost advantages say on a per ton basis or your economic returns that you get per ton versus say those fourth quartile mills?

Jimmy S.H. Lee

I really haven’t looked at the numbers recently, but of course I know that based on the production problems – many of these marginal facilities. The cost, the operating cost is significantly high and of course that isn’t really the main barrier I think in terms of the market right now. I think what is really important to understand is that you have everybody running and inventory levels are still dropping. And this will continue to build pricing momentum rather than really a weakness. And at the same time these guys ramp through the weak cycle. So even though they were losing money, they continue to operate. So we know that no matter what the pricing situation is going to be its likely that these guys will continue to run like they did. And that is why I view this particularly cycle very much differently than of the other current cycle that we’ve seen recently.

Andrew M. Kuske – Credit Suisse

Okay, that’s very helpful thank you.

Operator

(Operator Instructions) Your next question comes from the line of Andrew Shapiro Lawndale Capital. Your line is now open.

Andrew E. Shapiro – Lawndale Capital Management LLC

Hi, thank you, a few questions. And then I’ll back out. You made some money on the equity, money raised this quarter, have you already, and to what extent, downstreamed equity dollars down into Stendal, and did your joint venture partner coparticipate or what has our – Mercer's ownership percentage in Stendal increased up to now?

David M. Gandossi

Yes, Dave here. Yes, so we have not downstreamed anybody yet we’re anticipating doing that either late in the third quarter or really in the fourth quarter. As we disclosed in our offering material where we are going to put €10 million in as part of our commitments from the amendment that we did in 2009, we are currently negotiating with our minority partner and working with the banks on our structure. And we’ll just have to update you as that progresses.

Andrew E. Shapiro – Lawndale Capital Management LLC

Okay. And the log shipments due to the port strike and all that - absent the port strike, were you guys shipping or did you have, were you using the full container capacity up, whereby this, we'll call it rollback, into the current quarter of all the lost shipments pushes something from this quarter into the next quarter? In other words, is there a makeup in some incremental cash flow and revenues we ought to see as a result of the strike now being ended, or is it, in a sense, rolled forward constantly and thus permanently lost?

David M. Gandossi

No, it will, I would expect would be pretty much caught up by the end of the second quarter, Andy. So if we left 21,000 tons behind current EBITDA margins there is sort of $4.5 million to $5 million it will flip from quarter one and to quarter two on those tons will be my guess.

Andrew E. Shapiro – Lawndale Capital Management LLC

Okay. And since you are talking about a NAFTA claim litigation timing for the beginning of the court case itself to be mid-2014 and as we speak it is now May. Are there any particular milestones, hearings, timing that is already scheduled, in this case, for presentation of each party's case?

David M. Gandossi

Yes, so milestone for us was, we filed our memorial which is a massive document with all of our action figures and expert testimony and justification of damages and so on. Canada now has the period of time I think it’s three months, two or three months to respond and file there is and then there is questions replies back and forth a few times with arbitration in person interviews early in the 2015.

Andrew E. Shapiro – Lawndale Capital Management LLC

Okay. And when did you make the filing for the three-month time, when did start clicking away?

David M. Gandossi

Our memorial I guess three weeks ago.

Andrew E. Shapiro – Lawndale Capital Management LLC

Okay. And is that a matter of public records in Canada.

David M. Gandossi

No, it’s not at this stage now.

Andrew E. Shapiro – Lawndale Capital Management LLC

Okay, not at this stage. Great. And the last thing is, how big is the facility in Austria, I guess it was, that Jimmy referred to where there is some unexpected downtime, lost production, and how long might that kind of remodel or construction take?

Jimmy S.H. Lee

We think it’s an integrated mill right now and they have restarted one of their older small recovery folder, so our estimate of the impact from a market pulp perspective is around somewhere in the order about 14,000 tons per month type of estimate.

Andrew E. Shapiro – Lawndale Capital Management LLC

Okay, 14 a months. How many months is fixing this kind of problem generally take.

Jimmy S.H. Lee

Well, I mean it’s going to take many months, we think probably it would be a year maybe little bit more.

Andrew E. Shapiro – Lawndale Capital Management LLC

Okay, great.

David M. Gandossi

Great, thanks no more questions.

Operator

Your next question comes from the line of David Quezada from Raymond James. Please go ahead.

David Quezada – Raymond James Ltd.

Thanks, good morning guys. Just a quick question for you, and I apologize if this was addressed earlier, could you – and I know the Blue Mill Project is complete and was successful. Do you have any other sort of discretionary CapEx projects worth discussing over the next 12 to 18 months?

Jimmy S.H. Lee

Gentlemen, we got a few things I’m pretty excited about we are building a new toll oil – the first tall oil plant for Rosenthal as I think as a lot of listeners now we used to – and Stendal is our only mill of the tall oil plant, we used to ship soap from Rosenthal to Stendal and then we got so good at (indiscernible) Stendal that they fully utilizing and we increased the capacity of Stendal, so they are pretty fully loaded with around soaps, so we’re building a second tall oil plant at Rosenthal.

So Celgar focused this year is on their chip screen which is one piece of equipment that we think has a really big impact, positive impact if you modernize that, so that’s underway. And I guess the other really big focus for us is on our – on the wood side here in Europe we got a full core perhaps on all sort of strategies that not only will help us reduce our wood cost here at Europe, but also help us develop if you like bigger trading business or bigger footprint that contributes to lower wood cost, but also provide some margin for us as well. So lots to talk about in the coming years, things like railcar logistics we run about 300 railcar in Germany, so we’re focusing on that fleet, finding a way to get a deeper reach, lower the cost and those kinds of things. So in early days that quite excited about it, and none of it's really heavy capital but it's all quite accretive, we think, and strategically we’re very excited about the wood strategy in particular.

David Quezada – Raymond James Ltd.

And it’s a good color, thank you very much.

Operator

And we have no further questions at this time I’ll turn the call back over to the presenters.

Jimmy S.H. Lee

Well, I thank everyone for coming to today’s call and thank you.

Operator

This concludes today’s call. You may now disconnect.

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