Mercer International Inc.

Good morning and welcome to Mercer's International Third Quarter 2021 Earnings Conference Call. On the call today is David Gandozzi, President and Chief Executive Officer of Mercer International, and David Yer, Senior Vice President, Finance Chief Financial Officer, and Secretary. I will now hand the call over to David Yer.

Good morning, everyone. As usual, I'll make a few opening remarks about our financial performance before turning over the call to David to discuss our operations, our strategic capital program, the markets, and of course, our recent acquisition. I'd like to remind you 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. We achieved record EBITDA in Q3, primarily due to solid overall production and sales, strong end product pricing in most markets, and relative to Q2, a much lighter scheduled maintenance program. While somewhat mixed, depending on the particular market, our average NBSK price realizations remained stable and relatively high in the quarter. We also benefited from the impact of a stronger US dollar on our Euro and Canadian dollar denominated expenses. These tailwinds to our earnings were partially offset by modestly higher wood costs, particularly in our wood product segment, along with the weakening of the US lumber market. As we reported in July, we also operated our Rosenthal pulp mill for the quarter without the benefit of its turbine generator. The absence of green electricity generation at Rosenthal during the quarter negatively impacted our results by about $12 million. We are now roughly midway through the process of repairing the turbine generator. But as expected, the largest contributor to the sequential improvement in the quarter was the absence of heavy scheduled maintenance and capital downtime that we took in Q2. You will recall that we took 105 days of downtime in Q2 to both rebuild our recovery boiler at Peace River and complete most of the work to increase Stendahl's pulp and electricity production capacity. We generated EBITDA in the third quarter of $148 million, compared to EBITDA of about $84 million in Q2. Our pulp segment contributed record EBITDA of almost $130 million, and our wood product segment contributed solid quarterly EBITDA of $22 million. As usual, you can find additional segment disclosures in our Form 10-Q, which can be found on our website and that of the SEC. Changes during the quarter for softwood and hardwood pulp price movements were mixed across major markets. In China, the Q3 average NBSK net price was $832 per ton, down $130 from Q2. European list prices averaged $1,345 per ton in the current quarter, compared to $1,288 per ton in Q2. NBSK remains at a considerable premium to hardwood with the average Q3 net eucalyptus hardwood price in China at $623 per ton down $144 from Q2. In total, average pulp sales realization movements positively impacted EBITDA by about $5 million compared to the prior quarter. Pulp demand remained steady in the quarter and our higher overall production led to higher sales volume compared to the previous quarter. Our Q3 sales totaled almost 448,000 tons, which was up about 87,000 tons from Q2. In Q3, our mills were down a combined 44 days for capital and annual maintenance work. This is roughly the equivalent of 43,000 tons of production compared to 117 days or about 173,000 tons of production in Q2. The impact of the Q3 planned downtime compared to Q2, including higher production and lower direct costs, benefited EBITDA by $65 million. Our lumber realizations were also mixed this quarter compared to Q2. The Random Links US benchmark for Western SPF 2 and better averaged $495 per thousand board feet in Q3, which was down $848 from last quarter. Our average European sales realizations were up approximately $180 per thousand board feet compared to Q2. Historically, the European market has not been as volatile as the U.S. market and generally lags the U.S. pricing trends. The benchmark lumber price in the U.S. is currently about $620 per thousand board feet. Our wood product segment continues to perform well. We sold about 98 million board feet of lumber in the quarter which was down slightly compared to our Q2 sales volumes, primarily due to the mill taking a week of planned downtime in Q3. Our electricity sales totaled roughly 200 gigawatt hours in the quarter, which was up relative to Q2 due to less planned downtime. However, our sales volumes were held back due to the absence of the generation at Rosenthal for most of the quarter. Our Caribou pulp mill joint venture which is accounted for using the equity method, contributed another 20 gigawatt hours to this total. Included in these energy sales results, East River set a quarterly sales record, and Stendhal and Caribou both achieved near record level sales in Q3. We reported net income of $69 million in the quarter, or $1.05 per basic share, compared to net income of $21 million or 32 cents per share in Q2. Cash used in the quarter totaled approximately $46 million compared to $11 million in Q2. Our cash usage in Q3 was primarily the result of our acquisition of Mercer Mass Timber, our CapEx spending, and working capital movements in the form of higher accounts receivable and inventory. The uses of cash were partially offset by strong operational cash inflow. We invested $39 million of capital in our mills this quarter, and we remain on course to invest approximately $150 million in our mills this year. We also invested roughly $51 million in the acquisition of Mercer Mass Timber, our cross-laminated timber production facility located in Spokane, Washington. David will provide updates on our recent acquisition and our CapEx program shortly. At the end of the quarter, our liquidity position totaled about $647 million, comprised of $339 million of cash and $308 million of undrawn revolvers. Our strong liquidity position will support planned seasonal growth in working capital along with our ambitious 2021 and 2022 high return capital spending programs. We continue to work on finalizing the business interruption insurance claim associated with the recovery boiler we built at our Peace River mill. As a reminder, GAAP treats these types of insurance claims as contingent gains, which means that we won't be able to record the insurance proceeds until we have an agreement with the insurer. We believe the proceeds will ultimately be in excess of $20 million. In addition, we are now working on a business interruption insurance claim for Rosenthal's turbine downtime. As part of this downtime, we made the decision to pull roughly 50 days of major plan turbine maintenance from 2022 into 2021. As a reminder, our competitors report the results under IFRS are permitted to capitalize the direct costs of their annual maintenance shuts while we expense our costs in the period of shut completion. And as you will have noted from our press release, our board has approved a quarterly dividend of six and a half cents per share for shareholders of record on December 22nd, 2021, for which payment will be made on December 30th, 2021. That ends my overview of the financial results, and I'll now turn the call over to David.

Thanks, Dave. This has been an exciting quarter for us. We returned to normal production levels after an extensive period of maintenance and capital shuts in Q2. We achieved record earnings while navigating the ongoing complications of the pandemic, and we advanced a key element of our strategic growth plan with our entry into the mass timber space. I'll talk more about how this TLT acquisition fits with our view of a low-carbon, high-value add future for Mercer in a moment, but let's first review our operating performance. I'll begin by saying I'm very pleased with our record operating results this quarter. These results reflect the hard work of our teams during the period, often under challenging operating conditions, along with the benefits of our recent investments in Stendhal and Frigio. In Q2, Stendhal completed the work necessary to increase annual MBSK pulp production by 80,000 tons, and despite ramping up that equipment in Q3, still managed to achieve near-record pulp and energy production. In addition, Frijou's new planers, scanning, edge trimming, controlled drying, and sorting capabilities are providing the expected benefits of maximizing our production efficiency and great outturn. Overall, our mills ran very well, and strong production combined with overall steady demand for our products when compared to Q2 were key drivers in our strong results this quarter. Excuse me. I believe these results highlight Mercer's cash flow generation potential, considering we achieved these results with Rosenthal's turbine being down for most of the quarter, along with a long Peace River mill outage for the recovery boiler we built. Both of these situations will generate significant business interruption insurance claims, which as of yet have not been finalized. Our pulp markets were mixed due to regional differences that were primarily the result of global logistical challenges. We saw modest price improvements in Europe and weakening prices in China. where paper makers found it difficult to export to paper products due to high shipping costs. These factors, combined with energy usage restrictions in some areas of China, resulted in reduced paper production and overall reduced pulp demand. Meanwhile, in Europe, paper makers benefited from reduced paper imports and ran their machines full, creating solid pulp demand in that market. The negative Chinese pulp market dynamics were more pronounced on the hardwood side, in part due to expectations of new eucalyptus capacity set to come online. While softwood pulp capacity or supply in China was relatively tight due to delays in Canadian pulp deliveries, again the result of supply chain bottlenecks. We don't expect the supply chain issues to be resolved in the near term. Consequently, we expect generally steady MBSK pulp demand in Europe with reasonably stable pricing, In China, we expect a continuation of modest negative pricing pressure as energy restrictions continue and logistics channels remain constricted. We should all remember, however, how quickly China can bounce back once conditions begin to normalize. Currently, the price premium softwood commands over hardwood is at historically high levels, and we believe this discrepancy could remain for some time due to the different capacity growth trends for each grade. The August pulp statistics reflect increased producer inventory levels but these numbers need additional context as we believe the global logistics challenges are increasing the number of days reflected balance market. In addition, these statistics don't reflect paper producer inventory levels, which we feel are low due to logistics slowdowns and delayed buying, especially in China, as paper producers are not expecting pulp price increases in the near term. Overall, we believe that growing global economic activity will support demand for all commodities, including pulp, lumber, and extractives. We also believe government economic support will bolster this growth, and as a result, we are optimistic that steady economic growth and strong market fundamentals will support bulk prices. Our wood products business achieved solid operating results. The European lumber market was strong during the quarter, while the U.S. market experienced a significant correction. As we discussed last quarter, the correction was precipitated by a drop in do-it-yourself demand and fears the negative outlook could spread to the housing market. However, since mid-quarter, U.S. lumber pricing has been slowly increasing due to limited supply, in part due to the heavy wildfire activity in western Canada and higher stumpage fees. On the housing demand side in the U.S., despite modestly higher mortgage rates, housing starts have stayed steady and homebuilder sentiment remains positive. The European lumber market has shown steady price increases through the first half of the year, But as a result of the weaker U.S. market, we are seeing downward pricing pressure as some European producers reduce their exports to the U.S. market. We will continue to optimize our lumber products and customers to achieve the strongest sustainable realizations that we can. In Q3, 39% of our lumber sales volumes were to the U.S. market with the majority of the remainder of our sales in the European market. To date, Mercer has not been directly impacted by the global logistics challenges in a meaningful way, We are seeing modest increases in freight costs as we are forced at times to utilize more expensive modes of transportation or increase storage costs as a result of delays. We did have small volumes of pulp and lumber sales that will be recorded in Q4 due to shipment delays, but overall our logistics strategies are serving us well. Looking forward, Rosenthal's turbine and generator will likely remain down until the first quarter of 2022 as we affect the necessary repairs. At current energy prices, the negative impact of lost energy sales and energy purchases is roughly $4 million a month. Our wood product segment achieved another solid production result, producing almost 102 million board feet of lumber, which was down compared to Q2 due to a week of planned maintenance downtime during the quarter. In Germany, our wood costs, particularly for pulpwood, remain at historically low levels due to the abundance of beetle-damaged wood. and we expect this pulp log supply dynamic to generally continue in the fourth quarter, but expect prices to increase modestly. We are seeing strong demand for saw logs, which is driving some log cost inflation, but we expect our dedicated fleet of railcars will allow us to mitigate transportation cost increases that many of our competitors will be unable to avoid. In Western Canada, pulpwood supply remains steady and price changes have been modest in our fibre baskets. However, the impacts of the summer's fire season are being felt in the form of reduced sawmill activity, which we expect will create modestly higher fibre costs in Q4. While our annual major maintenance work is complete, significant capital expenditures to grow the company are ongoing. We are using our well-managed liquidity and strong balance sheet to continue to pursue the growth aspect of our strategic plan in areas where we have core competencies. Specifically, we have focused our growth on market pulp, building products, green energy and chemical extractives because we believe our expertise in these areas, along with our expertise in timber supply, procurement and logistics will add long-term shareholder value. We also recognize the importance of planning for the long term and as part of that we are putting a lot of effort into our transparency related to ESG practices, policies and performance. We are looking forward to the publication of our sustainability report in early 2022 which we trust will further support our messaging regarding our sustainability approach and values. Two good examples of putting sustainability and innovation into action are the Canadian Fibre Logistics and Processing projects, commonly referred to as the Woodroom projects. These projects will allow us to transform our supply chain, increase our capacity, and significantly reduce the cost to produce our own wood chips. The projects will also allow us to accept alternative forms of lower quality residual harvest wood that previously could not be effectively processed. As a result, we will lower our costs, improve our resource utilization efficiency, and reduce our greenhouse gas emissions. We expect the projects to be largely complete by mid-2022. We have continued to cautiously advance the engineering and permitting process for our Stendhal sawmill. The initial plan for the mill contemplates a 400 million board foot capacity with a product lineup and flexibility of our Friesvale mill, but we expect to build the mill in such a way that will allow for incremental capacity increases in the future. Currently, however, we are seeing significant delays in the delivery of sawmill equipment, along with large increases in capital costs for many components, including the equipment itself for steel, concrete, and electrical installations. We will obviously move forward cautiously on this and hope to advance this project at some point in the future when conditions are less challenging. In the shorter term, we expect to invest about $25 million of capex in Q4, putting our total 2021 capex at approximately $150 million. And while I have more to say on that at our next earnings call in February, we are expecting our 2022 high return capital plan will be quite ambitious with a portfolio of projects that will drive new product development, ESG advances, production improvements, and input cost reductions. The 2021 highlight of our growth strategy will likely be our recent acquisition of Mercer Mass Timber. This is an entry point for us into a sector that fits well with our value add solid wood strategy and a product whose end demand growth is very exciting. While we build up the order book for the plant's core product, cross laminated timber panels, we recently began producing long-length finger joint and lumber, and we expect to begin producing our first CLT panels in Q4. This facility has an annual production capacity of approximately 140,000 cubic meters of CLT, which represents about 30% of the current CLT manufacturing capacity in North America. We are truly excited about the CLT market going forward and believe that the environmental and construction flexibility benefits compared to traditional steel and concrete construction methods, make this product ripe for future growth. After considering our recent investments, Mercer's financial position remains strong. We will continue to take advantage of our financial flexibility as we move forward with executing her growth strategy. A catchphrase we're using a lot within Mercer these days is fit for the future. What we mean by this is that we strive to be on the right side of the climate change challenge, Given our role in managing forests and producing physical goods and green power from renewable resources, along with our focus on human talent and our strategy to operate only top performing modern mills, we believe and expect Mercer will be a welcome industrial player for the future. This will not be the case for everyone operating in our space and therein lies the opportunity. Now let me conclude by remarking that COVID-19 continues to be a concern, including the impact of variants on infection rates globally As a result, we remain focused on our protocols to ensure the safety of our employees, contractors, and the ongoing operation of our mills. And in keeping with one of our core values, I encourage everyone to get the COVID-19 vaccine to keep your families, friends, colleagues, and neighbors safe. Thanks for listening, and I'll now turn the call back over to the operator for questions. Thank you.