Mercer International's (MERC) CEO David Gandossi on Q2 2016 Results - Earnings Call Transcript

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Mercer International Inc. (NASDAQ:MERC)

Q2 2016 Earnings Conference Call

July 29, 2016 10:00 AM ET

Executives

David Ure - SVP Finance, CFO and Secretary

David Gandossi - President and CEO

Analysts

Dan Jacome - Sidoti & Company

Bill Hoffman - RBC Capital Markets

Hamir Patel - CIBC Capital Markets

Anthony Young - Macquarie

Andrew Kuske - Credit Suisse

Andrew Shapiro - Lawndale Capital Management

Sean Steuart - TD Securities

Sean Sauler - Redwood Capital

Howard Bryerman - Penn Capital

Operator

Good morning and welcome to Mercer International’s Second Quarter 2016 Earnings Conference Call. On the call today is David Gandossi, President and Chief Executive Officer of Mercer International; and David Ure, Senior Vice President Finance, Chief Financial Officer and Secretary.

I will now hand the call over to David Ure.

David Ure

Good morning, everyone. Thanks for joining us. As we typically do, I will begin by taking a few minutes to speak about the financial highlights of the quarter, and then I’ll pass the call to David to discuss the markets, our operational performance, and our outlook into Q3.

Please note 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.

In Q2 we achieved EBITDA of $34.7 million compared to $45.3 million in Q1 2016. Our Q2 results were heavily influenced by a very ambitious annual maintenance shut at our Celgar mill and several unrelated operating interruptions also at Celgar which prevented us from returning to full production for a further 10 days. We had a total of 21 days of maintenance downtime in Q2, 18 of which were at Celgar compared to no maintenance downtime in Q1. Combined, the downtime associated with the maintenance shuts created the $21 million drag on EBITDA in Q2 when we factor in maintenance costs, lost production and the negative impact on energy sales volumes.

On a positive note, pulp prices advanced higher relative to Q1 and we have achieved modest cost reductions in fiber, energy, freight and SG&A. We also benefited from the reversal of $7.2 million of previously accrued wastewater fees at our Rosenthal mill due to our meeting certain reduced effluent levels as a result of environmental capital improvements.

In terms of pulp revenue, the quarterly average RISI list price in Europe increased to $798 per ton from $792 in Q1 2016. In addition, the quarterly average list price in China went up to $617 per ton from $590 per ton in Q1. Our German Mills ran very well but as I mentioned our overall production was negatively impacted by a longer than planned maintenance shut and slow return to full production at our Celgar mill. The lower production volumes were also a major contributor to lower sales volumes which are down approximately 63,000 tons compared to the high volume sold in Q1 when we had no maintenance downtime.

We reported a net loss of $4.2 million for the quarter or $0.07 per basic share compared to net income of $8.8 million or $0.14 per basic share in Q1. Our interest expense was down approximately $0.5 million compared to Q1 which reflects the benefit of our $23 million repurchase of our 2019 senior notes in Q1.

Income tax expense in the quarter was $7.9 million, of which approximately $3.4 million was current. We continue to have significant tax assets to shield cash taxes that certain tax jurisdictions limit their use which will continue to create a modest current tax expense going forward.

You will have noted that our effective tax rate looks unusually high this quarter, a result that sometimes occurs under US GAAP when an issuer is consolidating entities from several tax jurisdictions. When consolidated earnings are low and companies with pretax income are combined with companies that have pretax losses, in certain circumstances, you end up with an unusual looking effect of tax rate. Longer term our typical accounting effective rate is about 30%.

Turning to cash flow. Our cash balance decreased by about $17.2 million in Q2 compared to growth in cash during Q1 of nearly $31 million. The principal contributors to the sequential change in cash flow in the quarter included the $23 million semiannual interest payment on our senior notes and the scheduled 5.2 [ph] million payment towards our Stendal interest rate swap. Also contributing to the lower cash flow this quarter were lower EBITDA and our planned CapEx program with [SAR] spending almost doubled to $13.9 million this quarter relative to Q1.

As I mentioned, capital expenditures grew almost $14 million during the quarter, the majority of which was spent on high return projects at Celgar and Rosenthal. Two of them are notable high return projects currently underway include a railway log delivery system and a lime kiln debottlenecking project both at Rosenthal. Also, we completed a lot of good smaller capital jobs during the Celgar shut that we expect will help reduce some of the variability in production that we occasionally experience there. We also spent about $400,000 on our ERP project. The project is progressing well and remains on target to be completed in late 2016.

And finally, our cash outflows in the quarter also included our quarterly $7.4 million dividend payments. Our liquidity remains healthy. Our consolidated cash flow was approximately $120 million at June 30, 2016. And we had about $138 million of undrawn revolvers between our three mills. Combined, that puts our total liquidity at about $258 million.

Our $120 million of cash at the end of Q2 includes about $8 million of restricted cash. These are funds that have been set aside to act as collateral for our Stendal interest rate swap. The collateral amount is contractually calculated and as the interest rate swap balance declines so will the collateral amount, subject to certain minimum requirements. This balance is down from $10 million at the end of Q1 and will continue to decline when our next scheduled settlement payment is made in October 2016. As you know, the interest rate swap matures in October 2017

On a trailing 12 months basis, our net debt is about 2.5 times EBITDA, a level that gives us considerable financial flexibility as we consider future capital allocation decisions.

And finally, you will have seen from our press release today – yesterday, pardon me – our board has approved an $0.115 dividend for shareholders of record on September 26 for which payment will be made October 4.

That ends my overview of the financial results. I’ll now turn the call over to David Gandossi to discuss market conditions, our operational performance and strategic activities.

David Gandossi

Thanks, Dave and good morning everyone. Our second quarter operating results were heavily influenced by our annual maintenance downtime. As Dave mentioned, the overall EBITDA impact was roughly $21 million in direct costs and lost production relative to Q1. Not surprisingly, our pulp sales were also down relative to what was a pretty strong Q1. However steady demand did push pulp prices up slightly this quarter.

June NBSK producer inventories were 28, down two days from the previous quarter end, which reflects in our view a pretty solid market -- balance in the market as we continue to see steady NBSK demand in all markets.

The July NBSK list price in Europe is consistent with June and the net price in China will likely settle a little bit lower. Growth in global NBSK deliveries continues to be steady at 3.5% year to date and China in particular remains solid at 6.7% growth when compared to the same six month period of 2015. Currently we expect steady demand in both the European and Chinese markets but with some temporary weakness in spot pricing in China during this typically slow summer period.

Looking forward we continue to believe that the global tissue markets growth will remain steady into the foreseeable future. We expect new issue machines to continue to start up especially in China which will further strengthen demand for NBSK. We also expect the supply demand fundamentals to limit the impact of slower buying trends that often occur in Q3.

Regarding the much discussed incremental NBSK supply coming on later this year and in 2017, we believe that the timing of these mill starts is such that the additional capacity will not negatively impact the market until late 2017. Our view on this is that overall NBSK prices are near floor levels for some producers on the higher end of the cost curve. Should prices slide we believe that high cost producers will be under significant financial pressure.

Moving to operations, as Dave mentioned, our Q2 production was reduced by our planned maintenance shuts and Celgar’s delayed return to full production. Between the 18-day maintenance shut at Celgar and a smaller three day maintenance shut at Stendal, and the slow start-up, we reduced our production in the quarter by about 44,000 tons. However our German Mills continued to run very well. In total we produced approximately 338,000 tons of pulp this quarter compared to approximately 378,000 tons in the first quarter of 2016 and approximately 359,000 tons in the second quarter of 2015.

I'm disappointed with Celgar’s slow start-up particularly because the shut itself went quite well. We got a lot of really good work done and we saw some early indications of the results of that work in June when we produced above planned levels. I'm satisfied with the diligent approach we took with the required maintenance work and expect it to enhance the mill’s operations going forward.

Consequently, despite Rosenthal’s scheduled maintenance downtime in Q3, I expect our production levels to be at normal levels in the coming quarter. As you would expect our pulp sales volumes were down significantly in Q2 and totaled approximately 330,000 tons compared to the exceptional 393,000 tons in Q1 and 371,000 tons in Q2 of 2015. Celgar’s production issues wound up pushing about 10,000 tons into the third quarter this year.

Turning to our energy sales. The mill sold approximately 190 gigawatt hours of electricity in the quarter compared to 207 in Q1 and 197 gigawatt hours in Q2 of 2015. Relative to the first quarter, our euro German fiber costs were down again continuing what has been a pretty steady trend over the past few quarters. Overall the German fiber market continues to be in balance. We continue to see sluggish demand for fiber from the board and pellet industries. So we expect German fiber prices in euro terms to trend slightly down through Q2.

In British Columbia, our Q2 fiber prices were up just slightly this quarter in Canadian dollar terms relative to Q1. We're currently forecasting that Celgar’s Canadian dollar fiber costs will remain essentially flat in Q3.

Our remaining 2016 annual maintenance shuts are scheduled as follows. In Q3 Rosenthal will have a 12 day shut and in Q4 Stendal will be down also for 12 days. With respect to our NAFTA claim, we don't have any new information for you but we continue to expect a decision in the second half of 2016.

So to wrap up, I'm very pleased to confirm that our Board of Directors has again approved a quarterly cash dividend. We’re pleased to be able to continue returning cash to our shareholders.

That's the conclusion of our prepared remarks. And I'll now turn the call back to the operator so we can open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Dan Jacome with Sidoti.

David Gandossi

Hello Dan, are you there?

Dan Jacome

Hi, can you hear me?

David Gandossi

Yes, there you are.

Dan Jacome

Great. How are you guys doing?

David Gandossi

Good, thanks.

Dan Jacome

So look at – I mean, what the market needs to see right now is, you’re saying Celgar is back to full capacity as of June.

David Gandossi

Yes, June was a good month for the mill.

Dan Jacome

And then just a couple of high level questions. So just remind us again on the wastewater fees. So you have discretionary CapEx projects and then you get paid back by the German government if you hit environmental benefits I guess.

David Gandossi

That's close, yes. So they are three year cycles, and we accrue a wastewater fee on a monthly basis. And then we have a discussion with the authorities and they have a program that says, if you can put some capital in to the mill that reduces your effluent parameters, and you have to discuss with the authorities what those parameters are, then you can use the capital spend as an offset to paying the wastewater fee at the end of the three year period. So we've got a history of doing that. Rosenthal's period ended December 31 of 2015, we did have a capital project in the preceding years that qualified and was agreed to with the authorities, so then you have to run the mill, have it audited so that the authorities can confirm that the parameters have been reduced. And then they send a letter confirming that your capital spend is an offset to the wastewater fees. So effectively the accrual then gets reversed as the fee is forgiven by the authorities. So that letter was received in the second quarter. So we booked it in the second quarter.

We had a similar program at Stendal. Their three year period ends April this year -- ended April of 2016 and we're still in the – and we had a capital project for that. We're still in the process of confirming with the authorities that the project met the objectives argue [ph] as they did but it needs to be audited by the authorities and we're expecting our pro forma would be released in the fourth quarter of this year for that wastewater fee.

Dan Jacome

Appreciate the color. And then on the dividend, I guess, it's encouraging [ph] your October payments lined up. Have your thoughts on the dividend changed at all given the 2Q production hiccups? I know things are back to normal but it looks like they have and I just wanted to confirm that.

David Gandossi

There's no change in how we’re thinking about that. We've always said that we expect that to be a sustainable dividend. There's ups and downs in this business and there are cycles but we've designed that dividend to be sustainable. It's reviewed every quarter by the board along with our operating performance. So it's something that we address every period but as I say we don't see any reason to curtail that at this stage.

Dan Jacome

One more and then I’ll get in the queue. Hardwood capacity, I know it's getting harder and harder to get the data on the days inventory. But do you guys have any thoughts on what you're seeing?

David Gandossi

On the hardwood side?

Dan Jacome

Yes, kind of on the days – day 28, 30, 40.

David Gandossi

We’re at 28 and hardwood’s up in the 40 range which is not unusual considering the distance that pulp has to travel. But hardwood is a little bit sloppy and will continue to be – and there's been lots of capacity additions and will continue to be capacity additions on the hardwood side. Having said that the guys in South America are still making quite a bit of money. So I don't see any change to that capacity addition. I think it's really happening.

On the softwood side, as I said we're a good balance of 28 days, that’s a tight market. China always slows a bit in the summer. It's not they don't need the pulp, they just hold off trying to grind the price a bit but generally a stable market. Europe is a very stable market. And the capacity additions this year and into early next year are not so significant. I just don't see that equation changing. It's going to -- it's sloppy on the southern softwood side. As IP [ph] brings their mill in and cleans [ph] come in but it's not a direct competitor to ours, it's in the market the low end of the Asian demand chain. It's a factor and it impacts the psychology of the market a bit. But NBSK markets are tight and I think they're going to continue to be tight well into next year.

Operator

Your next question comes from the line of Bill Hoffman with RBC Capital Markets.

Bill Hoffman

David, can you talk a little bit about -- you were mentioning with the softwood capacity coming on down through next year, it’s some of the higher cost capacity thing might come out of the market. Can you just talk a little bit about where it is at, where you see that capacity come out?

David Gandossi

Well, I hate to talk about competitors and things but there's a couple of mills in France. There is more than a million tons in Canada, little bit in Finland. There’s mills in Canada, they're being held up just by where the dollar is today – the Canadian dollar, it's a lot of really old capacity, lots of challenges in those mills. I'm sure the owners are struggling with the maintenance of business capital requirements that they have. And so it just is what it is. Our view is that the fourth quartile of NBSK is a very steep curve and there's 2 million to 3 million tons of capacity that would be on the bubble if we go – if we lose much more on price.

Bill Hoffman

And do you have any thoughts on sort of what that price difference is to where we are today?

David Gandossi

Well, as I said in my comments, Bill, I think it feels kind of flourish to me like I just -- I can't see it dropping another $50 without some sort of reaction on the supply side. I mean that's just my view.

Bill Hoffman

That’s helpful. And the second question, just given through your financial structure right now, flexibility, leverage levels et cetera, any thoughts strategically about where you want to go next whether it be acquisitions, additional capacity expansions if possible?

David Gandossi

Yeah, well, right now we're really focused on getting Celgar up to the 490,000, 500,000 ton range. I think that's a reasonable objective for us in the next year or so. I don't really see NBSK capacity acquisitions that we could make that would make sense for our shareholders, I don't think anybody's going to sell an NBSK mill cheaply these days, looking at out medium and longer term, these are going to be very valuable assets. And we certainly aren't in the market for junk. They're very expensive to run and I’d rather see some of the old stuff shut down. So we'll keep our eyes -- we're always sort of expanding our activities in our adjacent areas, logistics, harvesting, hardware procurements, and we're open minded about growth but right today's environment, this is not really something we should expect to happen in the near term for a variety of reasons.

Operator

Your next question comes from the line of Hamir Patel with CIBC Capital Markets.

Hamir Patel

David, could you give us a sense as to how substitutable NBSK is with SBSK? It seems like there's a lot of SBSK coming to market, and it seems like it’s getting price quite aggressively in China.

David Gandossi

Yeah, the southern softwoods are good fiber for some of the lower end guys, and those guys typically don't buy NBSK really ever, they don't -- they never need to pay the extra that it costs to get it. And when there is more SBK around that it's just -- it's better for them in a way but the customers that buy NBSK -- European and Canadian, they buy it because they need it. And just because SBK prices are dropping it doesn't typically don't switch. It is really just the noise that it's just the noise in the market and the price point in the market that they use to lever the price of NBSK down and we always take a really firm stand you see their different grades. I don't care what's happening in SBK. It's not relevant directly. You can't use it so. But it's -- that's just like I say it's a psychological factor in the market but if you're a high end tissue guy and you're making the court paper or thermal papers or high end fine printing papers. You can't use SBK, you use NBSK, you use your club to recycle or whatever else is in your firm. You don't switch between NBSK and SBK unless you're a low end paper grade that's traditionally buying cheap pulp whenever you can get it.

Hamir Patel

Just touching on your future growth, your referenced I guess NBSK mill valuation for good assets will be quite high. Just curious to get your thoughts on the fluff pulp market seems, there's a potential that we may see one or two mills come up for sale as part of the IP warehouse transaction. Just curious your thoughts about that grade and then also if you have an interest in any potential assets?

David Gandossi

Fluff is oversupplied, it’s going to be for a while. I don't really expect those mills are going to come on the market at a value that's going to be attractive to us. So I don't want to signal anything other than that. We're not going to buy expensive pulp mills today. So it remains to be seen what happens. I mean the nice thing about the fluff market is at least the concentrations with the guys. The big volumes coming out of the big guys fairly consolidated, so that is a positive for them. I've heard a rumor that Sun's fluff expansion in Arkansas may have switched to dissolving, so they'll that will be a positive for them going forward as in general but it is oversupplied right now.

Hamir Patel

It’s interesting and that dissolving thing. And just touching on your fiber costs, lots of discussions about potential antidumping countervailing duties for Canadian sawmills next year. If that were to take effect curious – what do you expect the impact to be on fiber costs in NBC if – duties?

David Gandossi

Well the nice thing for us is the sawmills in our region in Canada have -- they've got options in Asia. Obviously they're very -- the average exposure to the U.S. might be 15% or 20% or something like that. It's not nearly the risk factor that the guys back east would be going through. So there's two things there. In terms of fiber availability for Celgar I don't think much will change. I think the sawmills will keep doing what they do and the residual fiber will be available from that and the harvesting will be continuing and will be continuing around with programs. So I don't really expect any significant change to the fiber availability or the cost of Celgar as a result of this. But I think it may pulp producers in eastern Canada. They're going to struggle with fiber availability if all those eastern saw mills are hit with the kind of kind of duties that everybody is expecting.

Hamir Patel

Just sounds like it might actually have positive that leads to some capacity on the pulps that’s coming out. Okay, thanks so much David, I’ll turn over.

Operator

Your next question comes from the line of Anthony Young with Macquarie.

Anthony Young

David and Dave, just a question on the outage. I mean in your press release you guys say that your competitors capitalize this expense. Would there be thought, I mean given some of the volatility around earnings and your stock price that you guys might look to capitalize these expenses like in the future?

David Gandossi

That's an accounting doing very separate accounting principle question and. It's really the IFRS guys that are able to capitalize the maintenance costs and then amortize it through the depreciation line. As a U.S. public company and following US, John separate accounting principles, we can't do that.

Anthony Young

And then just with respect to where the ratings agencies are, I mean your metrics -- even with this one off quarter, the ratios and so forth but a pretty good. I mean do you guys still think an upgrade is coming?

David Gandossi

Well I don't -- they don't tell you these things run up a grade watch I think is the right term. Maybe we shouldn’t expect that after the second quarter we just had but our metrics. As we've said before metrics are clearly above the levels that the credit ratings agencies have us. So we're b1 under Moody's, as you know, and a B plus under S&P and you put a metrics through the through the filter, we're couple notches above but part of it's the momentum thing. I guess they have a whole lot of factors they look at. So yeah I think it's still but I am all that hopeful it’s going to happen in the next few months anyway because of the quarter we just had.

Anthony Young

And then just the last one, you gave the impact from an EBITDA perspective the outage. But your energy sales still look pretty attractive and would those energy sales go back towards where we were in Q1 if not for the outage or how much of an impact was the outage on energy sales basically?

David Gandossi

Well it's one third of Celgar’s capacity was during the quarter. The German mills which are the bigger contributors where they ran really well so.

David Ure

I’d add, Anthony, at the moment the big exports of energy are coming from the two German mills. It's not directly proportional to the volume. So where you see a drop in energy exports, electricity exports off and it's coming when one of the German Mills is taking their shut.

Operator

Your next question comes from the line of Andrew Kuske with Credit Suisse.

Andrew Kuske

Thank you. Good morning. Could you maybe give us some color in context on conversations with your customers especially in the run up to Brexit and then post-Brexit and just what’s the sentiments been like, some of the German economic data has been very sloppy.

David Gandossi

So those European customers you're thinking of.

Andrew Kuske

Yes exactly.

David Gandossi

It's almost like it's a non-event in a lot of ways for our customers in Europe. I mean their order books are solid. No questions about anybody curtailing their capacity or their orders everybody's -- orders early in the month and no big arguments on price. So I guess just we don't really feel it in the market to be honest. There's lots of discussions about what happened there. The general feeling in Europe is that this made a mistake, a lot of people are voting with their emotions and some of them -- the absence of a real understanding of what they were doing is what really sort of came out in the days following with all those questions to Google and things like that. But I guess most people assume they'll sort it out and Merkel's shown a patient hand like not forcing them into doing anything too quickly.

So Europe's got its issues but it's chugging along at the levels it's at and really don't really see that. Decks are changing that for the foreseeable future.

Andrew Kuske

That's helpful color and then just on the balance sheet, and you had talked upon -- your previous questions, how do you think about just the balance sheet positioning from a debt to equity mix on a longer term basis? How should we think about debt light levels, especially if we're going to see hopefully an upgrade in a quarter or two, how do you think about – for that market how should we think about the balance sheet?

David Gandossi

Yeah, well for the balance sheet, I mean we're quite comfortable. And a solid -- solid balance sheet but given what I said about our view of acquisitions of any capacity to make come available, not being very disciplined enough prepared to buy high cost capacity. We'll continue our debt reduction program and will continue to chomp away at the notes as and when we can in an appropriate way. And you know longer term I think that will create a lot of value for shareholders as we you know transfer the enterprise value across the across from debt to equity. And we as you say get rerated and you don’t get a couple of closures and you know we’ll be doing fine.

Operator

Your next question comes from the line of Andrew Shapiro with Lawndale Capital Management.

Andrew Shapiro

A few questions kind of close in the loop on the prior questions and answers you gave in the script. What made the Celgar’s maintenance plan this last quarter more as you guys said ambitious compared to prior maintenance shuts for Celgar?

David Gandossi

Well I guess it’s a good question. Andy thank you for -- the mill achieved 500,000 times in 2010 and the average of the last three years it's been more in the $460 million and it's just always sort of almost feels like -- we get hit by unexpected things, we don't really -- there was enough variability in what was happening that we realized we really got to do a deeper dive and figure out why that mill is struggling. So we had a task force of our – combining some of our Canadian engineers and brought over some German. Some of our German team did a deep dive and identified a number of these risky areas that are causing the mill these unplanned outages. And in an ambitious way we refocused on getting that -- a lot of that work done during this meet and shot. And the work as Dave said was well planned, it was well executed on budget but unfortunately when we were in one of the big flash takes, we found some metal corrosion that was significant enough that we had to do. Well the overlays on it and that part of the project just took time, so we had to add six days to the outage to get that tank back up to standard. And you guys did a good job of controlling costs and got additional work done during the outage extra days that they had and they have voided overtime and didn't work Sundays and things like that.

And when we brought the mill back up looked like it was going to be great. And then had like a series of three completely unrelated upsets that were in our business. It's just -- it's the nature of the beast, so we had. One was we had a leak in a large vessel that it's a carbon steel vessel that's pointed with tile and thinset, imagine like six inches of tile on the inside to protect the steel and there was leaks through the tile. And it just revealed itself a few days after the shut. This is a tank that's been in services, 1919, and it gets some inspected every year that impinges inspected this year and they resist somewhere in the tiling there is a crack and the material, the liquid was flowing through and heating out the carbon steel. And so we had to shut that system down to fix that and got the mill back up and running and then we lost a big piece of piping like an elbow on a pipe that -- the stock pipe that's going from one Leach tower to the next.

So the whole flow of this thing comes through this pipe and goes up to the next tower and this pipe elbow catastrophically failed, it's not related to – no work was done on the shut again if all the stuff gets inspected and it was we dropped 185 tons of pulp on the floor and it took a few days to clean up and got the mill back up and running. And then we lost power to the mill because of -- and believe it or not an osprey a dolphin asked on a hydro pole somewhere way away from the mill and shorted out the region that caused us to lose power to them to the water pumps to the mill.

Andrew Shapiro

So everything's up and running. Now you did the ambitious of maintenance from the programs you identified in the deep dive. Do you feel now that -- we'll be operating back up at the 500 range.

David Gandossi

Well I don’t want-- I've got to be careful. So we had really got a lot of the work done in a shut. We've got another big plan, we've got to do next year but we've basically worked through the list from the top down. So the most critical stuff is behind us. We've got another chunk of work to do next year but the same magnitude but we've fixed a lot of the latent issues that we're aware of and June’s performance is touchingwood here but the mill ran above budget for June which is a very positive sign that the guys are moving in the right direction there. So maybe I will –

Andrew Shapiro

So after this – then after at least this deep dive you have another one to do but after this deep dive the run rate should be above the 4.60 that –

David Ure

Yeah I think we should be making incremental improvement as we go forward here. Give us a year and a half but they’re getting better all the time.

Andrew Shapiro

Let's move on to a few other questions if I could. So you mentioned there's modern higher volume machine capacity buildouts. This has been a macro thing from Jimmy, and the new CEO. The modern high volume machine capacity build outs in China or frankly any developing country that requires an increased mix of softwood pulp to furnish that that should soak up the incremental new NBSK capacity which compared to hardwood there isn't as much being opened at all but there is some new capacity in NBSK. But you mentioned that this macro demand would occur. What impact have you recently seen and it’s importantly expect to see regarding the Chinese measures to accelerate the new modern capacity replacement from old more greatly polluting capacity or just less productive capacity?

David Gandossi

Yeah but that's been an ongoing and ongoing trend for several years. And every year it seems the impact of the closures in China become more and more relevant in the sense that in the early years they were mills on a list that were very small and nobody really knew where they were, what they were. But there were a lot of them and then and then the next year be up the list more slightly larger mills, slightly more relevant and bigger and bigger and it's the air pollution and the water pollution parameters that are -- that they're focused on and they're getting -- just increasingly tougher and tougher on those guys and the impact of that has been to create more demand from the bigger more modern machines to fill in what's being taken out by the old China equipment. It's as I say it's been going on for quite a number of years now. It's -- it's not a dramatic change to expect from this point going forward but it's just a continuation of the theme.

One of the things we don't talk about a lot but we should is that there's also this pretty significant decline in the recycle fiber availability because of the change of the profile of the end use of long fiber plus. You go back ten years it’s so much of this long fiber was going into printing and writing grades that can be captured in the recycling chain whereas that shift is gone from 65%, printing or writing ten years ago to 30% printing or writing or thereabouts and much heavier tissue into core papers and other specially papers that you can't recapture in the recycled chain. So that the reduction in recycle fiber is one of the drivers of demand for the hardwood guys, they're filling in that space with virgin fiber. But a lot of the paper grades do still need some level of tensile in them and that's where you get this creep demand from for virgin long fiber coming in to the reduction in a recycle basket. So it's not just new paper mills being built. But it's also a shift in the furniture globally that's part of that -- part of this whole theme.

Andrew Shapiro

You guys discussed the currency effects during this quarter but Brexit, happened at the very end of the June quarter and the U.S. dollar relative to other currencies greatly increased, so presumably the Brexit effect didn't have a huge effect on the second quarter results. Overall I mean we're now at the end of July, so one third of the quarters are already done and currencies have not gone back to the pre-Brexit level. So just overall what are the pluses and minuses here that you think the effects to the current Q3 as well as through the end of the year that might occur from I guess a relatively stronger dollar?

David Gandossi

Yeah, well the moves have been much lower than previous periods. The Canadian dollar is just slightly stronger in the quarter, been fairly steady. The euro was 1.13 for quite some time, dropped down to 1.10 back up to 1.11 today. I don't think these are really big drivers and I don't think consensus views are that they're going to be some big moves.

Andrew Shapiro

And I will move on, two more questions here. Following up on prior questioners’ inquiry about the credit rating upgrade and timing of possibilities, with no rating upgrade, maybe likely at least in the current quarter until there's. at least a more favorable trend for you and maybe some incremental debt paydown, are there any additional open market repurchases, opportunities, the call premium drop each quarter just annually, whereby it may make some sense to potentially take out some more of those 2019 or other notes?

David Ure

The call premium kicks in December 1 this year on the 2019 series. Until that date it's just open market pricing that’s available to us and we always reserve the right to take away our bonds as and when we feel it's appropriate. So I probably shouldn't say much more than that.

Andrew Shapiro

And last, what are your plans for investment presentations, non-deal road shows et cetera in the coming quarter five months and the rest of the year?

David Gandossi

So we've got we will be attending – it will be pretty quiet in August for us but we’ll be attending the Credit Suisse fixed income conference in the third week of September and then we will have a little bit of marketing to do on the East Coast with one of the banks, probably mid November and then in early December we will be attending the BofA industrials conference.

Operator

[Operator Instructions] Your next question comes from the line of Sean Steuart with TD Securities.

Sean Steuart

Good morning guys. And thanks for all the detail. Couple of questions. David, just wondering if you can go into a bit more detail on fiber costs in Germany. You mentioned the Q2 relief and that's been a recurring trend in recent quarters. Just going to a little bit more detail, I guess, on less competition from pellet manufacturers and the board industry. What the factors are there and your outlook for further cost relief on that front going forward?

David Gandossi

There was a time several years ago where the demand for fiber in Germany kind of got ahead of itself and we had cold winter, you had all these new pellet mills being built, new particleboard mills built and aggressive expansion of sawmilling and we've built our two mills. And it just got tight and it was really sort of like a new market. Our response to that was to think very differently about how we procure fiber in Europe and so we became quite aggressive strategically in particular with imports. So we've been investing as you know in logistics, increasing the efficiency of our rail capabilities, or port capabilities and even bringing a lot of wood into Germany. Meanwhile there's been about four of these large particleboard mills have shut down and moved east, the pellet business has been in tatters for several years, a combination of weather, excess capacity, guys bring in pellets in from other regions and so – and the sawmills are doing quite well right now. They've got a nice stable market in Europe and so they're running hard and making money. So it’s just generally -- it's just an easier market for us and we just continue to bring more and more wood into the domestic market which just sort of -- has the effect of sequentially pushing prices down. And it comes in small steps. Guys that are used to getting a certain price for wood all of a sudden like the sawmills have to -- they have to relieve themselves of this on mill chips but the but the wood on the stump, if a guy's used to getting a higher price and he doesn't like the price, he stops harvesting for a little while and then he realizes well things aren't going to get any better. Maybe they're going to get a little worse, so then he starts up again at a notch below and then he says I just have to keep grinding it down, grinding it down but we got enough. optionality now that when guys say they want more for their wood, we just say no thanks and go somewhere else. But I don't know if that helps but –

Sean Steuart

It does. What sort of order of magnitude year over year fiber cost declines that you see from German mills right now?

David Gandossi

Well, wood and a ton of pulp at Stendal has gone from the 300 ranges down into the 270 range now. Rosenthal's down in 240, 250 range per ton of pulp.

Sean Steuart

That helps. Apologies if you went through this already but do you guys have the volume by mill this quarter, I get a sense given the downtime at Celgar but do you have those details by mill?

David Ure

Sure, I can quickly run through them for you, Sean. So production at our Rosenthal mill in Q2 was 92,000 tons, Stendal was 165,500 tons. And Celgar was 80,800 tons.

Operator

Your next question comes from the line of [Deforest Tinmen with Walters & Company].

Unidentified Analyst

Can I go back and ask more of capital management questions? When you make the comment that you look at deals that everything is too expensive. We're not going to be able to do big debt refinancing transaction in the near term, maybe the call premium is little too high, unless you take away the debt in the open market but your stock, when you add back the grants it’s probably trying the book value, a very high free cash flow yield. When is a good time to buy your own stock and if so what is an appropriate leverage ratio for the company?

David Gandossi

Good questions. Well on the leverage ratio, down to 2.2 times net debt. Frankly that's comfortable. We would be totally fine to be above that. But on the stock buyback question, we've done a little bit of it about a year ago and I guess it's not something all of our shareholders like us doing, some of our shareholders want us to -- really want us to do it. It's just part -- it's just one of the ways to return cash to shareholders. At the moment we're focusing on dividend and debt reduction. But as we watch the stock, I mean it does start to get quite a feeling if you imagine it trending much lower than where it is today. So I just kind of leave it at that. We could debate it for hours actually and we have.

Unidentified Analyst

I mean it's good to hear your thoughts because the stock has moved around a lot over a long period of time. Management team is fairly vested, you guys have some pretty decent ownership especially Jimmy Lee, the dividend yield is obviously attractive. But if the market isn’t going to -- market that seeking yield hasn't really led to meaningful appreciation in your share price and it makes you wonder if a buyback would be more appropriate. So I’ll just leave my comment at that. And one other question, can you just give us an update on the rail initiative in Germany that you touched on briefly from a CapEx perspective? How far along are we on that project and how meaningful can that be in terms of lowering fiber costs?

David Gandossi

Yes. So the program has started to get in so, we run around 300 rail cars for roundwood in Germany and we lease these cars in the market and we've designed and are having built a new format of rail cars that is about 65%, can carry about 65% more wood for the same length of block train. And so the further east you go from us in Europe the cheaper the wood is and then it's just a question of the cost of the wood plus the cost of transportation to get it into the domestic market. So you can imagine with trains that are that much more efficient we can go that much further, get that much cheaper wood and continue to -- continue our strategy of bringing imports into the market to continue to push the price down.

Where we are in the program is so we've ordered 200 cars, about half of those have been built and have been brought into service and they produce -- by the end of the year we will be completely full with the 200 and then we've got another 50 to order which we will do in the near term which will be received within about nine months. So by the end of the year we'll have -- will be about 70% or 80% of the way along on the conversion from the old cars to the new cars. The lease cost for the new cars is very similar to the old actually. So it gives us a real leg up in terms of our ability to import wood from places further away.

Unidentified Analyst

How meaningfully does the cost of fiber drop, are you willing to say anything in terms -- because you have to be negotiating with some of these guys prepping them in terms of hey, we’re looking at many board feeder, loads of wood, I mean what is the -- what are the numbers we're looking at in terms of savings?

David Gandossi

Well you've seen your fiber costs coming steadily down over the course of the last couple of years. And I am just signaling that that's going to be – we’re defending that and pushing it hard wherever we can. I mean I don't want to signal huge swings in fiber cost but I think the trend is down and will continue to be for the foreseeable future.

Unidentified Analyst

And just so I understand, is that only a benefit to Rosenthal or is it a benefit to Stendal as well?

David Gandossi

No, both, Stendal consumes a lot of roundwood and so it’s both mills benefit.

Operator

Your next question comes from the line of Sean Sauler with Redwood.

Sean Sauler

Thank you guys and congrats on a good quarter in light of what happened with Celgar. Wanted to I guess touch on the balance sheet which I think a few other people have touched on. Is there a target leverage ratio that you guys think it's appropriate for the company kind of on a through cycle number?

David Ure

Well, yeah I think we're already through that threshold. I think the leverage is quite comfortable today. What else can I say, I mean we're going to continue to push free cash flow in that direction, continue the dividend and as you know we think about share buybacks and we'll have to continue to think about that as we see the performance of our stock going forward. But Sean, I don't want to say that we have a target of how much lower our leverage is going to be, we will knock away at it as and when we can. And it just makes us feel better and stronger as we do that but I'm not uncomfortable with where it is at all right now anyway.

Sean Sauler

And then I guess this is more of a holistic question, on the dividend yield which you guys from the last couple of years and at least we think over the next few quarters and next few years should generate a lot of cash in excess of your EBITDA minus interest and taxes and the dividend. Would you consider raising that dividend? That's the first part of the question. And then the second part of the question is I think you talked about capital allocation. How do you think about the yield that you would get on the bonds in open market purchase if you were to do that relative to the dividend --- current dividend yield on the stock? I think the dividend yield on the stock is higher than the bond yield which is probably a commentary on the market but I'm curious how you think about the two of them. Two part question. A long one.

David Gandossi

And I don't know how to answer part two to be honest but part one is, I think the board looks at the dividend level every quarter and we do in management as well. And given where the stock is in enhancing the yield, this is not a lot of pressure to raise it and it doesn't seem to really be helping the stock any way. It's quite disappointing actually how poorly the stock is performing considering our balance sheet and our returning cash to shareholders. So I don't think we should signal it's going to be increased in the near term and I can't – board obviously has a right to make a decision every quarter but I think we're going to be steady on it.

And in terms of bond yields versus dividend yields on the stock, to an investor like you versus how a company thinks about these things, it's a slightly different equation for us. And it just gets us into this whole debate of what is the right -- what is the right way to return cash to shareholders and from discussions with me, one of the factors is the size of our float, the liquidity in the stock, the optionality of being liquid when under various points in the cycle and being just steady prudent managers of the balance sheet to weather any of the volatility issues that the world may throw at us at any given time. So we just want to be as safe as we can, but not be too cautious either. So it's a balancing act. We look at it every quarter.

Sean Sauler

Understood. I guess obviously the commentary is, if you're comfortable with your leverage, or the current amount of leverage and you could by buying stock or actually buying a cheaper instrument that has upside versus the bonds which I think yield around mid-5% right now seems to be a better use of capital. I guess I would reiterate the Walhasen [ph] individual’s comments but thanks a lot guys and congrats on the quarter.

Operator

Your next question comes from the line of Howard Bryerman with Penn Capital.

Howard Bryerman

Yes, thank you. David, I just have a mundane of straightforward accounting question. And it's directed at the wastewater fee accrual. I think you said on the call that you reversed the accrual this quarter to the tune of 8 million and there's most likely more to come at the end of the year based on these capital project spends that once approved allow you to reverse it. I guess what I am a little confused about is it seems like it's -- why make the accrual to begin with? It seems like you know what needs to be spent from a capital perspective in order to get the necessary approvals and therefore reverse the accrual, it seems to like make earnings very choppy when you are reversing 8 whatever million dollars a quarter. It seems like -- and I am quite familiar with GAAP, it seems almost like it would be better just to book it on a cash basis if and whenever you have to pay the fee. And then the last part of it is, I assume it has no cash impact but are these fees being -- does it have a cash impact?

David Gandossi

So a couple of comments, it doesn't really have a cash impact. So we accrue -- so at the beginning we have a three year cycle. And the German authorities say if you can bring a capital project to us that allows you to lower your permit levels in whatever the negotiated grammars are, then bring it on. So at the beginning of a three year period, we're working on thinking about trying to develop a concept that we think will fly and we may go to the authorities with one and it doesn't fly, go with another, doesn't fly, go again with some other concept and they start getting interested so then we have to work our way through it. So that takes a year or more. And then we have to engineer the capital project itself, then we have to build it. And then we have to run it and measure and achieve what we said we were going to achieve.

And so in that degree of uncertainty under U.S. GAAP we're not allowed to assume that we are going to be successful. Although we've got a history of being successful and we have a high level of confidence as managers that we can do -- say we're going to do and we have strong engineering and all sort of capabilities it doesn't need to test that our auditors would require to not book that accrual. Once the test for us to release is when the authorities have been into the mill, audited the parameters, reviewed all of the invoices and then made sure we spent the money on the things we said we're going to spend it on and totally got their heads around the whole thing, and then they make a decision and they sign off and they send us a letter saying you're good. That's the point where the uncertainty diminishes enough that we can reverse the accrual. So I agree with your comment that it is choppy on earnings. We just don't -- we don't believe there is any other way to treat this from an accounting perspective.

Howard Bryerman

So just final -- how much should we expect through the balance of the year in reversals of this accrual?

David Gandossi

The Stendal program is just a little over 12 million euros. And if it's not as advanced as Rosenthal but as long as everything goes according to plan and it's successful that I would expect that to be released in the fourth quarter.

Howard Bryerman

And then just kind of as a general comment as a credit guy. Even though we do invest on your balance sheet. It never ceases to amaze me how management gets pushed on a short term basis to buy back stock or pay dividends and I think it's extremely prudent in your industry to keep your leverage as low as you do to keep your liquidity as high as you do. And to be extremely well prepared for the cycle ups and downs in the paper industry in particular. So kudos to you and your stock should reflect that as opposed to flushing out all your liquidity and then having a problem when you're in downturn. So thanks David.

End of Q&A

Operator

There are no further questions at this time. I turn the call back over to David Gandossi.

David Gandossi

Okay, well thanks everyone. That was a long call this morning. Lots of detail I hope, but we didn’t overdo it there for you but appreciate all your questions and your interest. And look forward to speaking to you again in the next quarter. Bye for now.

Operator

Ladies and gentlemen this concludes today's conference call. You may now disconnect.

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