Mercer International Inc. (MERC) Earnings Call Transcript & Summary

Good afternoon. I'm Roger Spitz, and I cover the High Yield Paper & Packaging and Chemicals sector at Bank of America and have the pleasure of hosting a fireside chat with Mercer International. With us today from Mercer is David Gandossi, President and Chief Executive Officer; and David Ure, Senior Vice President, Chief Financial Officer and Secretary. [Operator Instructions].

And with that, perhaps I'll start off with Q&A. Maybe I'm going to start with our CapEx guidance on 2021 and 2022 CapEx guidance.

Well, maybe I'll start there, Roger. Thanks for having us. We're delighted to be here. In terms of capital spending for 2021, we've been -- we've indicated that our target for this year is about $150 million of capital, much of which is high-return CapEx. So we've got a couple of really terrific projects that we're just in the final steps of completing, probably the most important one is an expansion of the Stendal pulp -- the pulp mill, where we're increasing the capacity of that bill by about 80,000 tonnes. So $150 million for 2021. And for 2022, we are targeting about the same amount, probably $150 million to $175 million of CapEx for next year. A couple of really interesting projects there that probably the 2 biggest ones or 3 biggest ones are wood room new wood rooms for our 2 Canadian pulp assets at Celgar and Peace River. These are facilities that will increase the capacity for -- and our ability to source alternative sources of wood for those pulp mills. And along with those projects, we're redesigning the entire logistics chain. So building new trucks with higher capacity that are able to transport more material, material that some of which in the past would not have been economic to bring out from the big out from the woods. So a couple of great projects there, and we're getting some government support to do those projects as well. Probably the third benchmark project for next year included in that amount is the expansion of our sorting capacity, our lumber sorting capacity at our sawmill in freeze-out. So this will be a piece of equipment that will allow us to take advantage of all the optimization and scanning equipment that we have with the sawmill to better separate and grade out the high return -- the high-grade lumber at that facility.

Excellent. In terms of working capital for Q4 '21, how should we think about whether it's in working capital inflow or outflow of cash?

Yes. I think for Q4, you could probably expect that there'll be a modest outflow due to working capital increases, which is fairly, fairly typical when we go into the winter months, we like to hold a little bit more wood inventories just to make sure that we don't have any problems in the first quarter of the winter, if the weather turns poor, we want to make sure we have access to fiber through the season. So typically, you would see our working capital rise a little bit in the fourth quarter and then it would relieve itself typically in the -- by the second quarter. David will talk more about this, but we've got a few logistics constraints in Western Canada at the moment. We've had some flooding that has tied up a few of our logistics chain. So that might also be a -- caused our working capital to rise a little bit as well.

Actually, I want to speak about that next is the impacts on the British Columbia flooding on both your operations specifically, if any, as well as the rail and road links, which I understand have been challenged.

Yes, maybe I'll take that, Roger. The -- yes. So the flooding almost 2 weeks ago now, completely severed all roads between the interior of the province and the coast, including the rail links for both CN and CP. It's been a continuation of incremental improvements. Highway 3 has been open on and off. The rails have been opening up a little bit on and off. There's still one more big storm coming apparently. So it's still challenged. We've been in the Alberta mill that would normally be shipping on the CN rail to the Port of Vancouver. We've been pushing it down to Edmonton and staging for when things do open up the Celgar mill, we can relieve the pressure there somewhat by pushing enters goods both into the BN rail system come over to the Port of Tacoma. We're trucking as much as we can, but truck capacity is limited, obviously. So it's been very disruptive for all of the Western Canadian pulp and lumber facilities. Our Cariboo mill, which is a joint venture with West Fraser up in Quesnel currently down scheduled to be down until at least the middle of December as a result of not being able to get the up to the market. Fingers crossed, things start to improve in the coming days.

Great. How about we shift to fiber pricing. What is your outlook for NBSK, NBHK pricing both in the near term and into 2022? And obviously, RISI's got their view, but I was wondering where you were shaking out.

Yes. Well, maybe just to put a little context into things. So listeners may recall, China prices were the first rise and they rose the most, I guess, since the beginning of the pandemic, then followed by the U.S. and Europe. China has recently dropped right back down into the high 600s. And our feeling is it's more or less bottomed out there and things are -- and it's been challenging in China recently with the energy outrages and the lack of export opportunities for them due to the cost of logistics. So China has kind of bottomed out at that 680, 690, moving back up now towards the 710, 720. Europe and the U.S. on the other hand, have been more insulated. European paper producers don't have that usual agent competition, though they're running hard and they're profitable getting their prices up. And so pulp prices have held in haven't really moved much in the past months. We gave up $40 from $1,340 to $1,500 for November, which is a sign that it's starting to creep down a little bit. Our view is not having a crystal ball, but our view is that the European and the U.S. markets will tend to come down a little bit and the Chinese market is going to tend to move up a bit until we get back to that beat in the middle, more normal type of situation. All the geographies are basically islanded at the moment due to logistics bottlenecks. So as those start to relieve themselves, I think on balance pricing should normalize more. Maybe next year might be something like a mid-cycle pricing on average, but it's pretty hard to tell. There's so many moving parts.

Great. There's a number of plants, some of the swing plants Brazil and Chile coming on, how do you think those will impact the market?

Yes. Well, there's -- I mean, there's so many drivers on these things, Roger. I mean, I think it's easy to sit back and think that well because there's several million tons of eucalyptus hardwood capacity coming on the market, that's going to be quite negative on the hardwood pricing or supply demand balance side of things. But there's also other really big impacts or drivers, one of which is recycled fiber, frankly, if there's 200 -- 400-plus million tonnes of paper board produced each year, half of that 200 million plus is recovered fibers. And some of the things that are changing are the end uses of fiber today are much less recyclable than they were even just a few years ago. The client and graphics papers and the increase in tissue and specialty means that there's less recovered and what is recovered as of lower quality. So the shifts in the recovered fiber market are actually bigger than the shifts in the Virgin fiber capacity in -- at least in my mind. So I'm not as negative as some analysts might be in terms of what's going to happen on the hardwood side. There's also -- there continues to be a really strong demand pull demand growth globally, and we're a long way from being out of this pandemic yet. So I'm optimistic that demand will surprise us on a strong side generally. For softwood NBSK, much smaller size component of the fiber markets, 15 million, 16 million tonnes. Another 1.5 years out from now, Metsa will complete their chemi expansion, and that will bring some new capacity in. But in the grand scheme of things, I'm not worried at all for the supply-demand balance for softwood for the foreseeable future. I think it will be quite tight.

Do you see customers saying, look, you've got great stuff, but our customers need to see more recycled fiber in some of their paper products? And so the demand is coming in lighter [indiscernible] I realize that can be hard to see if demand everything is going up because all boats rise in these kind of markets. But have you noticed that at all?

No. I mean, in fact, I would say more of the opposite. I think that there was a period of time where it became really invoked to push a recycled label but that furnish is getting harder and harder to get and hardest stain. And also recycled fibers don't low around the globe very well anymore, like you can't there's areas where there's large deficits and other areas where there's large surpluses obviously. So I don't -- I can't think of big conversions from Virgin to recycle lately rather more the other way around.

Does recycled fiber, would it potentially impact more softwood or hardwood or you don't even think about it that way?

Well, I think today, it's -- it would be more closer to the hardwood side as an alternative as opposed to an NBSK.

Got it.

Yes. Not a lot of long fiber and what is recovered these days. And by the time it's been recovered multiple times with strength, the strength of characteristics and structural characteristics are quite significantly diminished.

Right. Right. Shifting over to lumber. We've just been gyrating to some extent recently. What is your thinking there in terms of outlook, in terms of pricing?

Well, I'm personally bullish. I think there's supplier risks all over the planet as a result of climate change for fire bloods, all that kind of stuff. I think there's a lot of pent-up demand in the U.S. housing market. It's been underbuilt for many, many years. We saw the strength of repair and remodeling in the early stages of the pandemic. So I think it should be a tight situation for probably the foreseeable future. The U.S. market is the volatile one. It kind of leads up and it leads down. Europe tends to follow 3 or 4 months later. So some of the grades in Europe are just kind of waning off and the U.S. is obviously during the corner and marching back up quite strongly, it feels like. And I would expect that the Europe -- some of those European grades, by the time we get into the first quarter, are going to start to follow again. But optimistic for next year for lumber.

Okay. Do you think the -- I mean, obviously, you have to go through some time to find out on this, but do you think lumber cyclicality is perhaps it's still cyclical, but the peak and trough are each higher than the old peak and trough?

Well, recent history sure confirms that. It really feels that way, doesn't it? That -- I mean the size of the moves have been like we've never seen before. Like even today, I mean, we've had this massive falloff on price, but the price today is actually by historical standards at a fantastic price.

Yes. That's why I was thinking on those lines. It's a -- it's craziness. Any update on the EU inspection in terms of, I guess, NBSK?

Yes. There's nothing new, maybe just for the benefit of the listeners, so there's a cartel allegation against NBSK -- European NBSK producers. The way these things start is understanding typically would be a whistleblower or maybe a customer complaint some are along the line. I don't believe it's targeted to us specifically, I don't believe the company would ever participate in any kind of price discussion of any kind. But somewhere in the system, somebody has made a complaint, I guess. And so we're 12% to 15% of the global capacity. So we're caught up in it, obviously. We've been interviewed. Our marketing teams at their offices reviewed and copies of all their e-mails delivered to the EU investigators and so on. And good chance we won't hear anything for years, the way these things normally shake out. So by the same token, I don't think you ever get relieved from the investigation until it's over. So I think it's something we're going to have to [indiscernible] for the next several years.

Yes. Unfortunate. Maybe shifting to M&A. Can you speak about what your outlook is and Domtar, I guess, is looking at selling a mill. What can you tell us about what your appetite is for further M&A?

Well, we're definitely a growth-focused company for a whole bunch of reasons. But as we've been seen by the moves we've been making and the commentary in our recent quarterly reports, we're really focused on more lumber in and around our pulp mills to capture the synergies and temperate supply strategies and things like that. We're also very, very focused on mass timber. We just recently bought the Katerra Spokane facility, a great transaction for us, a really nice burgeoning platform in a rapidly growing space. So we're very excited about that. I can't really comment on the kamloops pulp mill. I'm sure a lot of industry followers would think it might be a fit for us, and it could be, I suppose, we wouldn't have gone looking for it I can't really comment on the mill. I haven't been there for years, but I know it is rate both on the Kamloops city, which is a bit of a worry. So we'll -- It's not something that's really actively on a radar screen at the moment to the way I put it.

Got it. And going back to the Stendal sawmill construction. Can you speak about the status on that?

Yes. So the history on that disclosure was the Free shall mill, which is near Rosenthal has just been a tremendous success, very, very beneficial to Mercer in so many ways. And we want to duplicate that up in the Stendal mill area. And the fourth up near Stendal is -- I mean, it's just getting to the right age to support another sawmill up there. So we've done the engineering and design work and thought it all through. And as we were getting to the point where it was time to get quotes from suppliers, we bumped into the pandemic and all of the consequential delays and cost increases and everything else. And it's I mean, it's frankly just crazy enough out there that we're not in a rush to do that project like we're just going to -- we're ready to go when things normalize again. But for now, we're just in a settled down mode we great access to fiber, everything is running well in Europe for us and not the time to take a bite at the apple when things are as crazy as they are, so be patient.

Got it. Maybe we're going to speak about the new Spokane, Washington CLT facility. What -- any kind of update on the ramp of that facility?

Yes. So when we bought it out of bankruptcy, there were no employees. So we've been recruiting and hiring production teams, maintenance, IT, finance, and marketing and order fulfillment and been very delighted with the quality of the individuals who have looked upon the Mercer team as a family they want to join. So I think we're going to have a very strong team there. The facility is now up and running. We're basically first phases to produce long-length fingertip product, which is buying railcars a lumber and finger joining and putting it together selling longer lengths for of average 28-foot product. And that's the precursor to getting all the wheels turning to start loading the press with the LP material. The order fulfillment process with CLT projects is a little longer. It's not like a commodity lumber product. It's something you actually bid on and then you start -- in time, we'll be stacking the projects on each other, trying to optimize the facility. So we're a ways away from that. But I believe we'll be making CLT within a couple of weeks. And in on optimization from that point forward. It's -- for those listeners that aren't really familiar with CLT, it's cross-laminated timber, if the plant can make plates of timbers, both 12-feet wide, 60-feet long and anywhere from 3 to 9 plys thick and then it flows from the press on to a CNC machine to cut it into the exact shape that it needs to be for the building, whether it's a floor plate or a wall plate or whatever the component is and it's becoming a very rapidly growing building product. It has great carbon benefits. It's sequesters carbon, great space for trees to grow. It's a value-add to lumber. It's an alternative to steel and concrete. It's lighter, it's faster, it's economical. So there's just a lot of benefits in -- and it's growing -- it's at the infancy today in North America. It's been around longer in Europe. European capacity is probably 6 or 7x greater than what is in North America today. But the CAGR for North America is it looks like it's most analysts but put it somewhere in the 30% to 40% range for the next 5 to 8 years. Very exciting new business product or platform for us.

How hard is it to get into that business? I mean, it's not like you're doing this before and it's specialized. So presumably, your customers say, well, because well, it's Mercer, so it's got to be good or they say, well, show us what you have, how hard is it at? And particularly mitotic commodity, is it harder to get in there?

Well, customers who are familiar with mass timber in North America would already know that, that plant is the largest and most modern production facility in North America, all the bells and whistles. So it can provide all the certifications, stress ratings, et cetera. And it's a very large facility. And as I was saying earlier, we've been very fortunate to attract to our team individuals who are very well known in the space who have a long history of project execution. And because we see this as a platform for growth, we're going all in, like we're really focusing on the A team. The combination of it being Mercer, a combination of the quality of the facility and the individuals that are joining our team, I have every reason to believe we're going to be successful.

Got it. How about if we shift -- [Operator Instructions] Maybe we can speak about inflation and input costs size, are you even handling them? How they've been impacting you?

Maybe well -- David, do you want to ...

Yes, so I can make a few comments about that. I'd say it's spotty, so we're beginning to see some indicators of inflation in certain parts of our business. So -- but I would characterize them to this point of being been fairly modest. And some of the places that we're watching carefully are chemicals. So some of our principal cooking chemicals in the pulp side of our business we're seeing some signs that we could expect some modest inflation next year for those. Our labor -- most of our labor is under a collective agreement of some sort, usually multiple years. So you'd see there's -- we're seeing some inflationary pressure on labor but it will be kind of bumpy over time. Seeing a little bit of inflation on certain elements of our freight costs. So some elements of the freight like the break bulk shipping is fairly stable, but some elements like trucking. So that the -- getting the pulp and lumber to the break bulk vessel, we're seeing some inflation there. Little bit on energy, but as most -- as you know, Roger and so our listeners would know, we're generally -- we're exporting energies. We consume some natural gas or part of the process and our pulping process. So we're seeing some inflation there. But we're also seeing some inflation on electricity. And we are a net exporter of electricity. So we're seeing some considerable benefits on the revenue line for electricity as well.

Got it. I guess we have time for 1 or 2 more, maybe. What -- maybe you can speak about the relative competitiveness of your NBSK plants relative to your regional competitors out there? I know they're big, they're large, relatively new, should be very well positioned, but I'll let you speak on that.

Yes. It's hard to be really specific. There aren't many providers of good cost curves anymore, but my feeling is that the German mills with their scale, their energy profiles on and where wood costs have been for the last several years. They're pretty far left, very low cost. Maybe just the Russian mills than because of foreign exchange and a few of the larger Scandinavian mills that are just super modern would be in that league or ahead of them, possibly. In the -- the cost curve is the first quartile, reps up and that it's really more a very gradual flat slope through the second and third quartile. And then in the NBSK space, the fourth quartile is where all the older mills, smaller mills. Our Canadian mills would be somewhere in the middle of the bench, that part in the middle, somewhere in the second quartile, probably, but very competitive with the average.

Perfect. Okay. Actually, we're just we're out of time. So listen, Dave and David, thank you very much for speaking with us this afternoon. Greatly appreciate it.

We appreciate the opportunity as well, Roger, thank you, and thanks BofA. Welcome.

Thank you. Take care now.

Yes. Bye-bye.