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

[indiscernible] paper and packaging, chemicals sectors at Bank of America and have the pleasure of hosting a fireside chat with Mercer International. With us today from Mercer is Dave Ure, Senior Vice President and Chief Financial Officer and Secretary; and Genevieve Stannus, Treasurer. Also this session is being webcast. So Mercer reports in 2 segments. Pulp includes the 740,000 met ton Stendal NBSK mill and the [ 360,000 ] met ton Rosenthal NBSK mill in Germany and the 520,000 met ton Celgar NBSK mill in British Columbia and the 475,000 met ton [ NBSK/NHBK swing mill ] in Alberta, Canada. Celgar also produces and sells a lot of electricity from its operations, mainly in Germany. And then in the second segment, Wood Products includes [ Friesau ] mill lumber mill in Germany, which Mercer acquired in 2017. It's a nice [indiscernible] integration [ play as sawdust ] from the lumber mill makes a great fiber raw material for a pulp mill. In August 2021, Mercer acquired the cross-laminated timber or CLT facility in Spokane, Washington. And in September 2022, Mercer acquired HIT, a German manufacturer of wood pallets as well as other products. As we -- we'll have a -- and then I'm going to turn it over to Dave, who will go through some slides, and then we'll go into the fireside chat. And during the chat, if you have questions, just raise your hands. We have a microphone, which is particularly helpful during a webcast. With that, Dave?

Great. I think I'll stand here so I can drive the slides. Thanks very much, Roger. We're delighted to be here. Thanks to Bank of America for having us. I'm here with my colleague, Genevieve Stannus, and we're delighted to be here and talk to you a little bit about Mercer International. Maybe to begin with a little bit of groundwork. At Mercer, we at Mercer believe probably like most of you in the room here, we believe that the reduction of carbon and the reduction of pollution, particularly plastic pollution will become this generation's greatest environmental challenge. And while that is a challenge and there is a lot of people, a lot of very smart people around the world working on this challenge and very dedicated governments and countries doing a lot here, we believe that there is a considerable role for the wood products industry in advancing these environmental objectives. We produce products that are carbon alternatives to carbon-intensive products. We produce products that are alternatives to plastics and other fossil generated packaging materials, including textiles. So we believe that there is an important role for the forest industry. And it's with that background. And also, I guess the other comment I would make on this is that while there is a role for the forest industry to play here, the resource itself is finite, particularly in North America. There is not an unending source of fiber to advance these products, particularly in the northern hemisphere. And it's with that foundation that we are advancing a 4 -- sort of a 4-pillar strategy that I'd like to talk to you about today. The first pillar of that strategy is the production of sustainable products. So we're producing products that are displacing traditional concrete and steel building methods. We're producing products that are alternatives for plastic packaging and even products that will someday make their way into textiles that are displacing plastic textiles. The second element of our strategy is world-class assets. So we believe that having a suite of portfolio of world-class assets, these will be the companies that are able to take this finite wood resource and segregate it into its constituents and add value for stakeholders. We also believe that a larger and more diversified form of Mercer would be helpful for stakeholders, and I'll talk a little bit about that here in a moment. And we're going to do that. We're going to do that growth and diversification while still maintaining a prudent but flexible and an agile balance sheet. A little bit of a few comments about our product spectrum here. If you looked at Mercer about 10 years ago and looked at us today, you probably -- there's elements of our company that you wouldn't recognize. You might have known us as a pure-play northern bleached softwood kraft producer and we certainly were that 15 years ago. But over the past 10 years and in the past 5 years, in particular, we've advanced up and down the value chain to produce what is a pretty wide scope of products today. So we're all the way from high-value construction materials, construction lumber and mass timber, building methods and building solutions for medium and high-rise buildings all the way through the pulp cycle or through the pulp product, NBSK is still a core element of our business, but we're also working our way into producing more green electricity, more extractives, all again, most of which are alternatives to fossil fuel-based products. And one of the interesting things about this product mix is that not only is it heavily focused on sustainable products, products that are competing with fossil fuel alternatives, but owning all of these product lines allows us to take advantage of the synergies between them. And what I mean by that is that the feedstock for some of these products is actually the residuals from another product. So the feedstock for heating pellets is a residual from our sawmills. The feedstock for our green electricity, our turbine generators is a residual from our pulp mills. So having all of these assets under 1 ownership allows us to take advantage of these synergies that if these were owned by discrete owners, they would have more challenge taking advantage of these synergies. I'll talk a little bit about our assets here in a moment -- for a moment. Our pulp assets are among the largest and the newest in the world, our NBSK pulping assets. And this is a big deal, not just because of the obvious cost benefits you'd get from having a larger production over your fixed cost. But having newer assets allows us to do things like generate electricity. So our mills generate enough electricity to not only power themselves but twice that much, and it's that extra electricity that we're exporting to the grid. If you have a pulp mill that is more than 15 or 20 years old, you're not able to do that. The other thing that it does is it allows us [ to a ] certain amount of agility for the future. So for example, today, as part of our -- we're generating electricity as part of our chemical recovery process. In the future, that may not be the case. We may want to take the lignin that we're currently burning as part of our chemical recovery process and using to generate electricity, we may choose instead to refine that lignin into its chemical components. So it's an investment, considerable investment that we're doing some work on. But it's an investment that you would not make if -- for a smaller, older mill, you want to have a solid foundation to be able to participate in these biomaterial markets in the future. And when we think about the solid wood side of the business, so this is the construction materials, construction lumber, for example, we think about it in much the same way as we think about our pulp business. We own 2 of the 20 largest sawmills in the world now, both of them are in Germany. And not only are they large but they're extremely flexible. These are mills that can be producing dimension lumber, kiln-dried, [ plained ] dimension lumber for the U.S. market, the Japanese market, the U.K. market in the morning and could be switching over to different grades, perhaps it's custom metric grades, [ unplained ], undried for the European market in the afternoon. They're mills that 1 of them could produce shipping pallets, heating pellets and electricity. So these are mills that have got a tremendous amount of flexibility and we can change their production to match the pricing that is in place for those products at that time. And this is a level of flexibility. Our portfolio of sawmill assets is more flexible than any other portfolio of sawmill assets that I know of in our space. I talked a little bit about building our company and growing it and diversifying it and there have not been many years when we have not bought in -- many years in the past 20 years where we haven't either bought something or built something at 1 of our mills. So we've been quite active. And today, our company is about 6x the size that it was even 15 years ago. And not only are we getting bigger, but we're becoming a little bit more diversified over time. And as you might imagine, as a company gets a little bit bigger, we're producing a little bit more EBITDA than we have in the past. There's still some fluctuation, some volatility in our EBITDA, our products are all cyclical products to some extent. But over time, as we diversify the products to the extent that they're not correlated with each other, the volatility of the EBITDA and the cash generation will moderate over time. In terms of capital allocation, this slide will not surprise you. We've been focused over the last 5 years and growing the company. So of the about $1.6 billion of cash that we have allocated to our company, we have a small portion that is going to shareholders typically in the form of dividends. We've got some interest, maintenance costs. But the vast majority, more than half of this -- the capital allocation has been into growing the company and diversifying the company either by M&A or by organic growth. In terms of the capital structure, we would characterize this as a fairly prudent capital structure, but quite agile. We maintain, despite the growth and the nominal value of the debt, we've maintained a net leverage level of 1.4, 1.5 for the last 5 years. You can see on the bottom right-hand side, the structure of the core of our debt structure is in the form of senior unsecured notes in 2 large tranches. And you can see that in the last few years, we've carried a little bit of liquidity too, and this is liquidity that we've taken advantage of a couple of times to pick up bolt-on acquisitions or completed an important M&A project or an important organic growth project that we may not have been able to do if we didn't have the liquidity in place at the time. Roger, maybe I suspect you'll have a market question or 2. I won't spend too much time on this, but maybe just a quick couple of comments on our 3 principal markets. In terms of pulp, we're nearing what looks like the end of a 2 or 3 quarter period of time where we've had fairly robust pulp markets in all 3 of our major markets in Europe, in North America and China. Looking forward to the next few months, we think that there could be some softening in Europe as Europe looks like it could be heading for some recessionary periods or recessionary conditions. But we do see some constructive things happening in other markets. For example, in China, after 2 years of China really being locked out of export markets because of shipping constraints, that's -- the shipping constraints are all starting to alleviate themselves now. There's more vessels available, the shipping rates are falling. So we're expecting that the paper production, the packaging production capacity out of China will start to come back and operate on a few more cylinders than it has in the last couple of years. Lumber is in a bit of a tougher period at the moment after some very solid lumber pricing in the last 2 or 3 years. We've got pricing today that is the lowest pricing that we've seen in the last couple of years. But some of the demographics and the big macroeconomic conditions that are supporting the lumber market are quite compelling at the moment. We have very, very low lumber inventories across the channel at the moment. So it won't -- we believe it won't take much to turn that into tightening conditions. If you look at the housing stock in the U.S. or North America in general, so you'll recall that lumber consumption in North America is really driven by new housing starts and repairs and renovations. And if you look at the age and the volume of the housing stock in the U.S., it's never been older and it's never been smaller than it is today. And the same trend holds true with the demographics. If you look at the age demographics of North America, never in history of we had a period of time where we've had this age group that's demographic between the ages of 30 and 35 that prime home buying age. So some fairly constructive large macroeconomic conditions behind a relatively weak lumber market today. And in terms of electricity sort of our third -- the third leg to our EBITDA at the moment, we've experienced some very high electricity rates in Europe as you probably all know, given the shortages of gas in Europe at the moment. We're seeing the prices starting to come down and the governments are now indicating that they will put in place a cap that looks to us, it will be around EUR 130 per megawatt hour of electricity introduced to the grid for biomass energy producers like ourselves. So at EUR 130, it's quite a bit lower than we've experienced in the last quarter or 2, but almost twice as high as the market conditions that we used to have if you went back 4 quarters. So still healthy margins for electricity. Maybe just a couple of quick comments about ESG for those folks who are looking for an idea and an ESG idea, think Mercer has some pretty compelling elements to it that are worth a look, maybe just a couple of validation points. As I mentioned, all of our products are sustainable coming from sustainable [ forest ]. They are displacing, in many cases, fossil fuel-based products or polluting products so the products themselves are very conducive to an ESG portfolio. We're currently being rated by 3 ESG rating agencies, and we recently announced and posted and disclosed our 2030 aspirational ESG goals, including a 30% reduction in GHG emissions and a 15% increase in sustainable or in certified forest wood consumption. And all of these objectives that we've disclosed have been -- recently been validated by the Science Based Targets initiative. So maybe I'll pause there. That's probably a good place for me to pause. Roger, again, thanks for having us and...

Thank you, Dave. Appreciate that. Again, if you have questions, just raise your hand, we'll bring a microphone over. But maybe I'll start it off. You talked earlier about size and growth. And you've certainly done a lot of inorganic growth. What is -- why is that a good thing -- I mean [indiscernible] a good thing as a general matter. But is there anything particular you like about it? Or is it I mean -- a banker will tell you, bigger companies get better valuations in the marketplace? Or is it more opportunities? Or is it more synergies between different businesses? What is really driving why you want to be bigger?

Yes. And I think, in short, it's all of those. I think our original idea about getting bigger was we wanted to be -- wanted to offer more for shareholders to offer shareholders an idea that they could get into our space, but when they decided they wanted to get out, they'd be able to get out a little bit quicker, too. So try to create something that was a little bit more liquid for shareholders. But one of the things that we've really discovered or has really hit us over the last 5 years is just the value of the synergies of being able to participate in that whole value chain. And I'll give you a couple of examples to bring it home. We bought a -- we bought this asset in Torgau in Germany a few weeks ago. And it's a wonderful asset, a wonderful, large mill that produces sustainable products. So they'll take a wood -- a log that they've harvested or purchased from a landowner, and they'll get -- they'll recover everything out of it. They'll make shipping pallets out of it and what isn't good enough to make a shipping pallet, they'll grind up into sawdust and make heating pellets. And what isn't good enough to make heating pellets, they'll put through a turbine or through a burner and make steam and run it through a turbine and make electricity. Absolutely no waste, fantastic asset. But what they were doing with the wood is making pallets, making small pallet boards. And it is a log -- this is a high-quality log that maybe what we would have done is we might have made a 2x4, a high-grade 2x4 for the Japanese market or a 2x6 that could be sold to Home Depot or Lowe's. And we might make some pallet boards from the outside of that log, but we would optimize and make sure that we're getting the full value out of that log. And it wasn't that the previous owners weren't aware of that. They just didn't have the ability to do it. We have assets just down the road from this that we can -- we've got the scanning capabilities of the kiln dryers, the grading facilities that we can do that. We also have other sources of sawdust that can be used to make heating pellets. Today, that sawdust we might be burning at 1 of our pulp mills to make electricity. Maybe there's more value in making heating pellets from this mill. So it's about moving wood around, moving the residuals around and making sure that the residuals are all going to the right place and getting the most value out of the wood. And we see that a lot through all elements of our business. One of the advantages of being large.

That's interesting. But of course, once you start with saying that's what you want to do, it's almost limitless what you can do. I mean where -- is there a focus you want to be [ at ] because when you go into wood, there are a lot of things you can do. You could be buying a lot of things. I don't think you're going into containerboard industry [indiscernible] you know what I'm saying is that there are many things.

Yes. Yes. And I think you could expect us to be more focused on when I say wood, probably the solid wood side if I go to the more upstream, more in solid wood, so construction lumber, mass timber solutions is something that we're applying a lot of resources on at the moment. It's a building solution that -- we don't see a lot of here in the U.S. yet, but it's very big in Europe, a little bit bigger than the U.S. in Canada. It's something that the building [ codes ] that have now accepted and are adopting. You'll see us spend more time and effort there. And I think you'll also see us, I'll call it, downstream in the extracted. So trying to make sure that we're getting -- we're recovering the biochemicals out of the lignin that today, we're burning in a boiler, and we're making green electricity that is displacing probably a fossil fuel at the moment. But at some point down the road, that may not be the best use for making electricity. It might be a chemical recovery process. And so we'll be spending a lot of time on that. And maybe just coincidentally, we have a new CEO named Juan Carlos Bueno that came in and joined us in May this year. And the biomaterials is his wheelhouse. This is his space. He's a globally recognized leader in this space came -- cut his teeth at Stora Enso where they are probably the world leaders in developing lignin and wood extractors. So I think it's -- you can probably expect us to see us supply some resources there, too.

So there's a question? Yes, wait for the mic since we're being webcast. Thank you.

Just following up on that. Just curious, when you're thinking about these acquisitions, are they more sort of tuck-in? How -- what size or type of acquisitions are you looking at? Just not familiar if you have a leverage target or where you're sort of willing to go on that? And then maybe what are you kind of seeing right now in the current market environment?

Okay. Yes. So a couple -- a few things there. I would say at this point, if I look at what we've done in the last 5 years, they've generally been tuck-in acquisitions or bolt-ons, something that we could absorb with our liquidity. For instance, the last acquisition we made was just under $300 million. We paid -- we used some of our liquidity, our cash to pay for that. We bolstered our revolving credit facility a little bit, took on a little bit more debt to pick that up. So there's opportunities for $100 million to $200 million to $300 million, depending on our liquidity at the time, we could bolt on without impacting the leverage much, particularly if it's coming with immediate EBITDA. But we're also preparing ourselves for the opportunity there might be something bigger that comes along. And while our leverage is quite low, I would say, quite low at the moment at about 1.4x or 1.5x on a net basis. We would be willing to let that go up to the high 2s for the right transformational acquisition, particularly if we could see an EBITDA materializing very quickly after that acquisition and being able to get the leverage back down to the low 2s. And the other thing I would say is that having that liquidity in place has allowed us to pick up a couple of acquisitions that I'm certain in hindsight, we would not have been able to pick up if we didn't have the cash available. If we had to go to the markets, we probably got a struggle to get those acquisitions done. So that gives us a bit more agility that maybe some of our competitors don't have.

So on the last call, you started talking about this the lignin and you talked about it again this afternoon. So Borregaard, big in lignin. If you look at some of the other guys who want to get into lignin, it was sort of like in a JV with Borregaard, I'm thinking Rayonier Advanced, for instance, Sappi in South Africa, Rayonier Advanced was in [ Fernandina ] Beach, Florida.

Right. Right. That's right, yes.

So would you look to get in with someone like Borregaard or someone else who say, "Look, we understand this market. You're bringing the lignin, we're bringing the market expertise. Let's do that?" Or would you get into this on your own?

Yes. I think it is to be determined, but we actually have some strong mines on lignin and the commercialization of lignin in-house. We've got a group that -- some very well-known lignin experts in the house, including our CEO. And I think the first step that we're going through is a pilot plant. We're building a pilot, a lignin pilot plant that should be completed by the end of 2023. And that will really be the first steps because lignin, it's one word and all pulp producers produce lignin. But lignin is a very different -- has a very different composition depending on where you are in the world and what you're consuming, what your underlying wood consumption is. So our first step will be to study our lignin, understand the components, the chemical components, and from there, we'll be able to figure out what are the commercial opportunities for those chemical components. Some of the end uses for lignin are well developed already. For example, adhesives is a very well-developed market. And then there's some that have got some that they're coming. For instance, carbon black is an area that there's a lot of folks doing some work on, not quite there yet, but quite a spectrum of opportunities, all with the opportunity again to displace a fossil fuel or carbon alternative.

[indiscernible] be like a different lignin for pretty much each 1 of your mills. Your pulp mills are [ going to different ]. And in fact, if you changed your wood basket a little bit as you -- I mean, that's going to change the lignin competition...

Yes. Absolutely.

It's not one thing.

Yes. Yes, that's right. We have 2 pulp mills that are 200 miles from each other. And without having the pilot plant completed yet, we know that the lignin between those 2 plants is considerably different. So you're right.

Got it. How -- when you think about potential recession that's coming up, how do you think about the recession resilience of the pulp industry?

Yes. It's certainly -- it's more -- much more resilient than 10 years ago or 15 years ago. You might remember, if you went back that far when NBSK was the dominant pulp, virgin pulp in the world, that was before the days of big commercial quantities of hardwood pulp from South America. This would have been a time of concern, I think, because you'd have big swings in demand, big swings in prices, and that would be enough where you'd have periods of time where some mills would curtail because they couldn't -- just the pricing wasn't there for them. Fast forward to today, all those high-cost mills or most of them are gone now, and the NBSK's base has tightened up considerably. And every NBSK mill on the planet has been running as hard as it can really for the last decade. And then if I look at where the NBSK is going, that's another clue as well. In the old days, NBSK would go into all the magazine grades and it would go a little bit into new sprint and it would go into the photocopy paper that we all use. And all of that material would become depressed in a recessionary conditions. Fast forward to today, it's really only about 1/4 of NBSK consumption goes into some sort of graphic paper. And it's really the graphic paper space that is subject to recessionary conditions. Other end products are less impacted. So if I think about tissue grades, for example, generally performed fairly well through recessionary periods. Packaging performs fairly well through recessionary conditions. [ The ] graphic paper can have some deterioration. But -- so to answer your question, much different than we would have been a decade ago or even 5 years ago for that matter.

Got it. Thank you. It looks like we're actually out of time. So Dave, thank you very much for speaking with us this afternoon. Very informative.

Well, thank you.

Thank you.