Mercer International Inc (MERC) 2015 Q2 法說會逐字稿

Good morning, and welcome to Mercer International's second quarter 2015 earnings conference call. On the call today is Jimmy Lee, Mercer's Executive Chairman, and David Ure, Senior Vice President Finance, Chief Financial Officer, and Secretary. I'll now hand the call over to Jimmy Lee. Please go ahead.

Thank you. As many of you know, this was the first time that David Gandossi would be addressing you as Mercer's President and CEO. Regrettably David and I have been traveling for the past few days, and as bad luck would have it, he has come down with a bug that will prevent him from addressing you personally. To that end, he has asked me to lead the call today on his behalf.

Let me begin my taking a moment to introduce David Ure, to those of you that he hasn't had the opportunity to meet. He has worked with David Gandossi off and on over about 15 years. He was David's Controller at Pacifica Papers in the early 2000s, and then went on to assume that same role in the larger company when Pacifica merged into what eventually became Catalyst Paper.

We are thrilled to have him join us at Mercer in 2006, as we continued our growth trend when he became our VP and Controller. He took a leave from the forest industry between 2010 and 2013, when he took on the VP Finance role at a tech company, Sierra Wireless, but returned to Mercer in 2013.

He has well over 15 years of senior financial leadership in the forest industry, and considerable experience in the capital markets, and the past Best Practices of large modern global publicly traded companies. He has a Bachelor's Degree in Finance from the University of BC, and is a Canadian CPA, CGA. His appointment is testament to the focus that we have, as a Company we've been able to apply the succession planning.

I'm confident in a seamless transition. I know David's experience and calm demeanor will serve him well in his new role. Please feel free to call him with any questions or comments that you may have.

As noted in our recent press release announcing these recent executive changes, I'll continue to be active as Mercer's Executive Chairman of the Board, and in this role I'll be continuing to be primarily focused responsibility for driving the development of our corporate strategy. I'll now pass the call over to David Ure, to cover the key financial aspects of Q2. David.

Thank you for the introduction, Jimmy, and good morning everyone. Please note that in this morning's conference call we will make forward-looking statements. According to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995, I would like to call your attention to the risks related to these statements, which are more fully described in our press release, and with the Company's filings with the Securities and Exchange Commission.

In Q2 we achieved EBITDA of $50.0 million, compared to $61.3 million in Q1. Pulp demand was strong in the quarter, however currency movements put pressure on NBSK pricing, and the quarterly average RISI list price in Europe fell to $855 per ton from $887 in Q1. And while the quarterly average list price in China went up to $670 per ton, it came under some pressure late in the quarter, as the markets begin what is traditionally a slower period during the summer.

As well, our Q2 EBITDA was negatively impacted by approximately $12.4 million, as we successfully completed our annual maintenance check at Stendal in the quarter. After considering the Stendal annual maintenance shut relative to Q1, our pulp production was down slightly this quarter. However, we were very pleased with Celgar's reliability in the period, and Rosenthal completed its most productive six month period in the history of the mill.

Our energy sales were negatively impacted by the Stendal shut. However, this negative impact was partially offset by the ramp up of our new tall oil plant at Rosenthal.

We reported net income of $16.4 million for the quarter, or $0.25 per basic share compared to net income of $13.6 million, or $0.21 per basic share in Q1. Our Q2 income includes a noncash foreign exchange gain on intercompany debt of approximately $2.2 million, or $0.03 per share.

Our current taxes totalled approximately $3.1 million this quarter, which is testament to our growing profitability. We continue to have significant tax assets, but certain tax jurisdictions limit their use, thereby creating a minimum tax expense.

The US GAAP IFRS differences related to annual maintenance had an impact this quarter, when comparing our EBITDA to those of many of our competitors. In Q2 we expensed direct costs of approximately $8.6 million on annual maintenance. The majority of which would have been eligible for capital treatment under IFRS.

With regards to our cash flow, our consolidated cash position was down slightly in Q2 compared to Q1, as our total cash decreased by about $9 million. Contributing to this cash reduction this period was a EUR10 million repayment of the PIK note used to finance the purchase of Stendal's noncontrolling interest, and we made a scheduled settlement payment of approximately $7 million on our Stendal interest rate swap.

Capital expenditures totaled approximately $12.7 million during the quarter, and generally comprised high return projects split roughly equally among our mills, along with approximately $1 million towards our new ERP project. The ERP project is progressing well, and remains on target to be completed in 2016. Our cash flow also reflects a temporary growth in working capital totaling $24.4 million, primarily due to higher receivables resulting from sales that were heavily weighted to the final month of the quarter.

In terms of our liquidity, our consolidated cash balance was sitting at approximately $100 million at June 30. In addition we have had approximately EUR28 million of undrawn revolvers available at Rosenthal, EUR52 million of revolver availability at Stendal, and approximately CAD29 million available at Celgar. Combined with our $100 million in cash, our total liquidity is approximately $213 million.

Our $100 million of cash at the end of Q2 includes approximately $9.5 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 based, and as the interest rate swap balance declines, so will the collateral amount, subject to certain minimum requirements.

Our net debt to equity at June 30 is down compared to Q1 at approximately 1.5 times equity. The decrease in this ratio was primarily due to higher equity balance resulting from the slight weakening of the US dollar on the translation of our foreign currency denominated net assets, which flows through the accumulated other comprehensive income line of our equity statement.

As I noted previously, we had a $2.2 million noncash foreign exchange gain on our intercompany debt this quarter. This foreign exchange gain was driven by accounting rules that require management to determine the long and short-term nature of these intercompany relationships.

As a result of restructuring our debt in 2014, we now have much more financial flexibility than in the past. And as a result we are classifying more of these intercompany balances as short-term, which results in foreign exchange gains and losses being recorded on our income statement, the magnitude of which are dependent on currency movements.

That ends my overview of the financial results. I'll now turn the call back to Jimmy to discuss market conditions, our operational performance, and strategic activities.

Thanks Dave. I'd like to start by saying we are satisfied with our second quarter operating results. Our mills generally performed well during the quarter, and our sales kept pace. The decrease in EBITDA in Q2 compared to Q1 was primarily driven by currency movements, and slightly lower pricing compared to Q1.

However, as our mills ran well in the quarter this helped maintain our low operating costs in general, including our local currency unit, fiber costs in both Germany and Canada. June NBSK producer inventories were at 29 days, down four days from the previous quarter end. We're not surprised to see this decrease in producer inventories in Q2, as the Chinese New Year holiday and the seasonality traditionally create additional demand in Q2. At these inventory levels the NBSK market is considered to be in balance.

NBSK list prices in July are $980 per ton in North America, $850 in Europe, and $650 in China. There has been some confusion in the reported China prices, so I'll clarify our perspective on this.

You'll recall the May China list price was $670. The industry announced a $20 increase for June, but didn't get it. List for June therefore was effectively $670. Prices are off $20 in July, but volumes are good. However, we believe we are approaching floor level pricing in China, and see the small hardwood/softwood price gap as a potential short-term NBSK pricing catalyst.

In Europe the strong US dollar has put downward pressure on prices in the quarter, but overall pricing has been fairly steady. Looking forward, we expect new tissue machines to continue to start up, especially in China, which will ensure a steady demand for NBSK. We're experiencing the usual seasonal price weaknesses in the early part of Q3, but we expect the supply/demand fundamentals to apply upward price pressures late in Q3 in China, and that Europe pricing will remain fairly steady through Q3.

We remain optimistic about the future supply/demand fundamentals for NBSK pulp. We see demand growing in emerging economies, particularly in China, in a variety of grades including tissues, specialties and board. Specifically we estimate there are approximately 3.1 million tons of incremental tissue capacity coming online globally in 2015, with approximately 1.5 million of those tons coming online in China.

Today the softwood/hardwood price gap is zero. As I noted earlier at these price levels we believe we will see incremental NBSK demand as paper producers will use additional softwood in their furnished recipes to get the benefit of the higher productivity.

Turning to our pulp production as previously commented, Q2 was a strong production quarter for us. All of our mills had solid production. In total, we produced approximately 359,000 tons of pulp this quarter, compared to approximately 363,000 tons in the first quarter, and approximately 354,000 tons in the second quarter of 2014. Q2 included our planned maintain outage for Stendal. Our pulp sales volume were up in Q2, and totaled approximately 371,000 tons, compared to 350,000 tons in Q1, and 357,000 tons in Q2 2014.

Turning to our power sales, the mills sold approximately 197 gigawatt hours of electricity in the quarter, compared to 199 gigawatts in Q1, and 197 gigawatt hours in Q2 2014. Relative to the first quarter our euro per unit German fiber costs were essentially flat in Q2. Overall the German fiber market is 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 remain steady, with downward price pressures through Q3. We continue to monitor this market closely, and we are very focused on opportunities to reduce our German fiber costs going forward.

In British Columbia our Q2 per unit fiber costs were up modestly this quarter in Canadian dollar terms relative to Q1. We anticipate that Celgar's Canadian dollar per unit fiber cost will decrease modestly in Q3, due to reduced levels of pulp logs in Celgar's fiber mix.

We're currently quite comfortable with each mill's fiber inventory levels. The timing and duration of our remaining 2015 annual maintenance shuts are as follows. In Q3 Rosenthal has 14-day shut, and in Q4 Stendal will have a short 2-day shut.

With respect to our NAFTA claim, the final hearing has been wrapped up this week and we now expect a decision in either late 2015 or early 2016. Regarding the NBSK market, we're expecting the usual summer dip in NBSK demand, but we believe that the supply/demand fundamentals have created a solid floor, and we expect upward price pressures to continue to return in Q3.

As I noted earlier, we continue to believe that the incremental tissue supply will drive strong pricing. We continue to be optimistic about the medium to long-term NBSK supply/demand fundamentals, which we foresee as being driven by increasing economic standards globally.

In addition I'm proud to announce that our strength in capital structure and our business outlook has allowed our Board of Directors to approve the initiation of a quarterly cash dividend. Mercer's first quarterly dividend distribution totaling $0.115 per common share will be paid October 5th this year for shareholders of record on September 29. We're excited to be returning cash to our shareholders, while continuing to grow shareholder value by investing in our business and pursuing accretive strategic opportunities.

In closing, let me emphasize how pleased I am with our recent progress. We have a strong culture in Mercer that thrives to be the best in the class. We have modern and profitable mills. We have recently completed a significant recapitalization that provides financial flexibility to further develop Mercer to the benefit of our shareholders. I'm pleased that we are able to seamlessly transition our CEO leadership to David Gandossi.

That is the conclusion of our prepared remarks. I'll return the call back to the operator, so that we can open the call for questions. Thank you.

(Operator Instructions). I'll pause for just a moment to compile the Q&A roster. First question comes from Dan Jacome, Sidoti, your line is open.

Good morning. How are you?

Very good.

Thanks for taking the question and David, congrats on your new role. Congratulations on the dividend as well. I was wondering if you had any thoughts of that. How should we expect that to go forward? Would you see yourselves increasing it, maybe some sort of step-up function, or maybe what sort of internal metrics will you be looking at going forward?

Well, I think that the amount of the distribution that we have started with, we felt very comfortable that it was one which was sustainable, throughout the cycles that we would typically envision. Of course, we can never anticipate serious dislocations in the global economy, but it accounts for of course what we believe to be weaker points within the traditional cycle, and we feel very comfortable that this level of distribution will be sustainable for the long run.

Now in terms of the further adjustments to that, we believe strongly that, of course as we build up cash and our mills continue to perform, and with our present outlook in terms of the medium to long-term, NBSK price movements, et cetera, we believe that these dividend streams will continue to be adjusted upwards probably. Of course the amount of those movements will be conditional on our overall liquidity assessment and our investment needs, especially in regards to very high accretive type of projects, and opportunities that may arise in the future. But at this point, as I clearly indicated, the level that we have chosen is one that is sustainable for the future.

Okay.

I hope that answers your question.

Yes. Definitely, it helps. I appreciate it. Then switching over to transportation costs, I know they nicely declined again, but at a slower rate of decline versus 1Q. I wonder if you can give us a little bit of flavor of what's going on there, maybe breaking it out in terms of FX impact, maybe railcar shortage, or whatever you're seeing.

Probably this is not the call to get into details, but I can give you more of the general trends of what we're seeing.

Yes.

What we're seeing in terms of the bulk area, of course we continue to have prices decline gradually. And that's also true for many of our container traffic.

However, in the ports that of course impose this kind of CO2 emission type of penalties, you're seeing those pricing of course increase, as a result of the supplemental fees that they have to charge. So what you're seeing really is continued gradual decline, which has been offset to a degree, depending on the ports that we are shipping to, because of the climate change, supplemental fees, if you may.

Yes, okay. Great. Appreciate that. And then just quick housekeeping. I know you mentioned the global stock days for softwood, I think under 30 again. Did you mention, maybe I missed it, the hardwood days? Do you have that?

No. The Brazilians have chosen not to give monthly balances.

Okay.

And they have chosen -- well, they claim that they will report quarterly and, therefore, there is no up to date monthly balances.

Okay. All right. Just checking. All right, really appreciate it and thanks a lot. Good luck with the rest of the quarter.

Thank you.

Your next question comes from Andrew Kuske with Credit Suisse, your line is open.

Thank you, good morning. I guess just a bit of a follow-up on the dividend question, and how you're thinking about balancing the dividend, effectively cash return to shareholders with your own capital investment plans. Could you maybe give us a bit more insight as to what you're looking at, as far as capital investment goes, the magnitude, along with the return potential?

Well, we've kind of stated that each of the mills typically, on a maintenance or kind of high accretive type of investment program, we're looking at probably like EUR10 million and $10 million US per year type of capital investment.

Of course all of the mills have extensive long-term capital planning budgets, and therefore, we are pretty good in terms of determining the level of investment activity that we are likely to incur over the next five-plus years. And that is why, considering those type of investment schedules, overlaid with our view of the general pulp cycle, and of course stress testing that with the typical type of up and down that we have seen, even in extreme cases, we feel very comfortable that our level of dividend distribution is sustainable. And that's why we've chosen this particular number.

Okay, that's helpful. And just for clarity's sake, there's no real outsized capital investment opportunities at the current set of mills.

No.

That you've got right now?

No.

Okay. And then just something completely different, are there any fundamental changes to customer behavior, or is this sort of normal course of business we are seeing with the typical slowdown at this point in time, and things maybe getting back end loaded in the year? Nothing has really fundamentally changed. You gave great color earlier on in the call, but I wanted to dig into that a little more.

Well, I think that basically the recent weakness in the China market of course is to a degree driven by more of the speculative buying that occurred early on in the year. There were expectations because of the supply and demand type of situation for softwood that price movements in China would start to recover more marketably, and the Chinese traders of course bought in anticipation of that.

Unfortunately, the price movements, although they went up, did not of course move as aggressively as I think the traders expected or hoped, and then as going through the summer, this market typically is weak. So of course in anticipation of that, there has been liquidation of the inventory, which of course has driven prices down in China.

And at the same time, I think the paper market as such, in terms of the publishing grades, as you know, and certain other grades of course have overcapacity in China, and of course they of course are under pressure. The tissue guys continue to expand. As we move forward probably, we'll see overcapacity in that sector too, but at the same time of course they still need to supply their mills. And so generally, certainly in the China market, we're not experiencing anything that is atypical of the cycles we've seen.

The pricing development in terms of United States is much different than, I think, traditionally because I think a lot of the buyers are moving away from contractual type of volumes to more spot type of volumes, which probably is more indicative of kind of the China market. That is because of course the North American market is oversupplied with good quality NBSK, so I think the movement there is different than in the past, where you had more long-term volume commitments, et cetera, et cetera, and pricing, which were more determined longer term. I think what you're seeing is more kind of China type of demand moving forward.

In terms of the European market we're seeing pretty much what we've experienced in the past. The price movements are pretty determined more by currency issues than supply/demand. The demand is steady. Supply is okay.

So any adjustments that we're seeing is really our push to get prices up, because of the currency movements on occasion, and then again, them of course resisting, because in the prior months the currency had gone against them. So it's a bit of a tug and war between the two of us, because the currency euro and dollar has been very volatile, as you know.

Okay, that's very helpful. Thank you so much.

Your next question comes from Paul Quinn with RBC Capital Markets. Your line is open.

Yes, thanks very much. Couple of questions. One on your -- you mentioned that you settled your hearings with NAFTA. What can we understand the timing of the decision, but is that a, you either win or you don't win? Is there a gray area, in terms of awards? What can we sort of expect at the end of the year, or early 2016?

Well, I mean, the win or loss is determined by the level of penalties. I mean, if we lose of course we'll get no award. If we win then we will get a significant award. So I think the gray area is the range in between that, of course the high end and the zero. So, that, we don't know.

Of course our experts, as well as the Canada experts have presented the case as to why we support the level of damage claims that we have indicated. It is up to the panel to determine what is fair and justifiable. And that I cannot comment on.

Of course we feel very confident that we have a very strong case. The evidence that has been presented by both sides and certainly from our side, we feel very confident that we have the right side of the argument. But like any court arbitration type of procedures, one never knows until the final outcome.

Okay. So it's not a case of you make a claim?

No. I mean, we filed a damage claim, and of course there's the method on how we determine the amount that we have filed. We have of course filed that. And then we have the expert, which of course supports those arguments. And then of course Canada tries to contradict, or tries to poke holes into our calculations.

And then of course it's up to the arbitrator's final decision to see what they feel is justifiable. So it's very difficult to know. It's not like, okay, if we win we get the maximum amount. If we win we'll get either the maximum amount, or somewhere between zero and that amount. We're confident that we have a very valid claim.

Yes, I like your claim too. In terms of your tax assets, maybe you could give us some details on where those stand right now?

David?

Yes, so roughly, and you can pick this up in our annual filings, but roughly in Germany we've got about $100 million of losses. So those are the, that's the primary basis for our tax assets. In the US we have about $55 million, and in Canada the losses are lower than that, but we've got a significant, as you'll see from our filings, we've got significant tax base in the capital assets. So fairly good shield for the time being.

Okay, that's great. And then just last question. Heard recently from a South American partner that eucalyptus will trade at a premium in the future to NBSK.

I don't buy that argument, because clearly from a productivity perspective, running a machine, the softwood is better. The characteristics in terms of softwood fiber versus eucalyptus in most cases better. So I would definitely question that eucalyptus pulp will trade consistently at a premium to NBSK.

Okay. Thanks. Best of luck going forward.

Thank you.

Thank you.

Your next question comes from Andrew Shapiro with Lawndale Capital Management. Your line is open.

Hi. Thank you. A few questions here on your Cap Ex. You spent some Cap Ex over the last few years to build out and open up this Rosenthal, I think tall oil project you thought would get $2 million a year in incremental cash flow from it. Has that borne out to be about the levels of cash flow you are now pulling out? Is it going according to plan? And then what is the next kind of incremental productivity or cash flow generation project on the horizon?

Yes, I mean, in terms of the tall oil project in Rosenthal, it is meeting our expectations. There is no question that the original project study, as well as the return calculations, and the improvement in EBITDA calculations definitely were conservative. There is a degree of seasonality to the tall oil extraction because of course, it is an extract from the tree. During the dryer periods typically there's less tall oil, as an example. So some of it will be seasonal, but clearly the indications are it's living up fully to our expectations.

In terms of the next type of accretive type of projects, each of the mills have a significant amount of accretive projects which are all two years or less. These are in all areas of the operation, from the wood logistics, to again the tall oil upgrade, and further extractive type of projects. So I think we're very comfortable that our continued focus on not just cost reduction, but improvements in terms of byproduct profitability will continue.

At Celgar, we will continue to focus on increasing their power generation. We know that there's a lot of potential there, that we have not yet been able to close the gap on. And recently we had our power specialist from the Stendal operation move to Celgar, and he of course has started the process of determining the areas where we can further extract and save on the same, so that we can now really close that gap aggressively.

Okay. And the last question for me is, and as I used to ask of David, maybe David has that on his calendar now. What are your upcoming, I guess, I'll call it investment presentations non-deal roadshows? What's on the agenda here for the August through October/November period?

Yes. So we have got a couple of things we're working on. The one that's firmed up at the moment is we'll be attending the Jefferies Industries Conference August 12 to 14 in New York. We're also hoping to do a bit of a, it will probably be an East Coast tour later in the summer, or early in the fall. We haven't firmed that one up yet, but our next one is the Jefferies Industrials Conference.

Very good. Thank you.

Thank you.

(Operator Instructions). Your next question comes from Sean Steuart, TD Securities. Your line is open.

Thanks. Good morning. Question on capital allocation, and this goes back to the dividend and your thinking there. But with limited discretionary CapEx needs, and I guess not a lot of ambition near term on the M&A side, how should we think about your target leverage levels, whether it be debt to cap, debt to EBITDA? Any targets you guys are focused on attaining over the next little while?

Dave, do you want to comment?

Well, I guess I would say that where we're at now, or where we're heading, so that would be in the mid-2s of interest coverage on a net basis. We're not uncomfortable with that.

We're trying to set up ourselves, as Jimmy mentioned, the level of the dividend. We wanted it to be something significant. We wanted it to be something that's maintainable, but also something that gives us a bit of room should we want to pursue an activity, be it an M&A activity or a large project. We've got the capacity to do that.

And then as we mentioned in the past, we've also set up our debt, such that a piece of it is repayable. In fact you may recall that the short bonds, the 2019 bonds that we issued last year. The first, or they're callable next year, at the end of next year. So I think we've created a structure that gives us quite a bit of flexibility going forward.

So we're certainly doing quite a bit of work. We're modernizing the mills, as Jimmy was saying, and doing quite a bit of work to grow the Company, and we're ready. We've got the flexibility to do that when we bump into something.

So I guess the two tranches in terms of the maturity dates for the bonds are kind of like the measures of our expectations, in terms of the reduction in debt moving forward, and more the permanent level of debt for the future. Hopefully that kind of clarifies your question.

Yes, very much. Thanks guys. Appreciate it. That's all I have.

There are no further questions. I'd like to turn the call back over to Mr. Lee. Please go ahead.

Thank you very much for attending today's call. It's unfortunate David was really seriously feeling under the weather. I'm sure he would have been very excited to have been able to be here, to make the call for the first time as the new CEO.

I'm very confident working with David over 10-plus years that he will continue to play a very good role, and take on his new position as CEO very productively and effectively, and I do believe that the transition has been a very smooth one. And at the same time, I think it allows us, as Mercer, to really move forward to the next development stage that we envision. So on that note, I thank everyone and goodbye.

This concludes today's conference call. You may now disconnect.