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spk10: You are currently on hold for the conference call. Today's call will be recorded. At this time, we are assembling today's audience and plan to be underway shortly. We appreciate your patience and please remain on the line. Good morning and welcome to Mercer International's second quarter 2022 earnings conference call. On the call today is Juan Carlos Bueno, President and Chief Executive Officer of Mercer International, and David Yor, Senior Vice President, Finance, Chief Financial Officer, and Secretary. I will now hand the call over to David Yor.
spk02: Good morning, everyone. Thanks for joining us today to discuss what has been an eventful few months for us. I will begin by touching on the financial and operating highlights of the second quarter before turning the call to Juan Carlos to provide further color on the markets, a strategy update, and of course, our recently announced acquisition. Juan Carlos was appointed President and CEO effective May 1st, and I'm delighted to introduce him to you on his first analyst conference call with Mercer. As many of you know, Juan Carlos is a globally recognized leader in the wood products and biomaterial space and brings to our company leadership qualities and expertise that will help us drive our growth in the years to come. We are excited for his appointment. Also, for those of you that have joined today's call by telephone, there is a presentation material that we've attached to the investor section of our website. But before turning to our results, 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. This quarter, we achieved EBITDA of approximately $145 million, compared to Q1 EBITDA of roughly $155 million. This solid result was principally a consequence of strong demand for all our products, leading to sequentially higher pulp and lumber prices, along with the positive impact of a stronger U.S. dollar being offset by the costs and lost volume associated with our planned major maintenance downtime. In Europe, the natural gas shortages that are providing us record electricity revenues are also creating conditions for inflationary pressure on energy-dependent input costs such as pulpwood fiber, chemicals, and to some extent freight. The quarter results also included a $13 million positive adjustment reflecting the reversal of a payable relating to three years' worth of wastewater effluent fees. The reversal is a result of German authorities waiving the fees after we demonstrated certain reductions in effluent load in connection with recent environmental capital expenditures. After giving consideration to our planned shuts at Selgar and Peace River, our mills ran well this quarter when compared to Q1, when we had no scheduled maintenance. Going forward into the second half of the year, we will complete 14-day planned shuts at both Rosenthal in Q3 and also Stendhal in Q4. Our pulp segment contributed quarterly EBITDA of roughly $102 million, and our wood product segment contributed record quarterly EBITDA of $49 million. You can find additional segment disclosures in our Form 10-Q, which can be found on our website and that of the SEC. Demand for pulp was stable in Q2, and supply constraints pushed prices higher than Q1 in all of our major markets. In China, the Q2 average NBSK net price was $1,008 per ton, up $109 from Q1. European list prices averaged $1,437 per ton in the current quarter, compared to $1,330 per ton in Q1. The price gap between NBSK and hardwood narrowed this quarter due to strong upward pricing pressure on hardwood with the average Q2 net eucalyptus hardwood price in China at $815 per ton up $147 from Q1. In total, average pulp sales realization movements positively impacted our EBITDA by about $39 million compared to the prior quarter. Overall, Our average lumber realizations also increased in Q2, despite the US market weakening significantly late in the quarter, in part due to strong European prices. In the US, we experienced excellent pricing in the first two months of the quarter before prices decreased significantly in the final month. The random lengths U.S. benchmark for Western SPF 2 and better averaged $866 per thousand board feet in Q2, which was down $408 from last quarter. Our average European sales realizations were up approximately $112 per thousand board feet compared to Q1. Since the end of the quarter, U.S. pricing fell further but appears to have hit a floor and has since been slowly moving up. Today, the benchmark lumber price in the U.S. is currently $670 per thousand board feet. Our electricity sales reflect strong generation along with elevated prices in Europe, where prices continue to be in the range of $200 per megawatt hour. Exports to the grid totaled about 225 gigawatt hours in the quarter, which was up modestly relative to Q1. We reported consolidated net income of $71 million for the quarter, or $1.08 per basic share, compared to net income of $89 million, or $1.35 per basic share in Q1. Cash generated in the quarter totaled approximately $84 million compared to cash generated of $65 million in Q1. Our strong cash generation in Q2 was primarily the result of working capital movements in the form of lower accounts receivable balances, a consequence of lower sales volumes. Capital spending in the quarter totaled about $47 million and we remain on target to invest about $175 to $200 million in our operations this year. Juan Carlos will provide an update on our CapEx program in a moment. At the end of the quarter, our strong liquidity position totaled about $771 million, comprised of $495 million of cash and $276 million of undrawn revolvers. Our quarter end liquidity position will support our recently announced acquisition of Holtz Industry Torgau, along with our planned working capital movements and 2022 high return capital spending program. In connection with the Torgau acquisition, we have obtained a bank commitment for our German revolver that will expand it from 200 million euros to 300 million euros. we can draw up to 100 million euros from this facility upon closing of the HIT transaction. And as most of you have noted from our press release, our board has approved a quarterly dividend of seven and a half cents per share for shareholders of record on September 28th, 2022, for which payment will be made on October 5th. That ends my overview of the financial results and I'll turn the call over to Juan Carlos.
spk01: Thanks, Dave. Our strong Q2 operating results were driven by increased pulp and lumber pricing, continued strong energy pricing, and a rising U.S. dollar. We completed a very ambitious maintenance program at both Selgar and Peace River, and as Dave mentioned, while we have experienced considerable inflation on natural gas, chemicals, and fiber in recent months, we continue to achieve record levels of electricity revenues that are helping to offset cost inflation. We have had a tough start to Q3 with the recent Woodyard fire at Stendhal, but we are today on the way to recovery, and I'll speak more to this in a moment. But before I speak about the fire and our HIT acquisition, I'll make a few comments about current market conditions and our capital expenditure program. In terms of pulp markets, global pulp supply-demand fundamentals remain tight through Q2, And as a result, relative to Q1, average pulp prices were up in all markets. Chinese demand continues to be negatively impacted by pandemic conditions, but we're beginning to see improvements as lockdowns are becoming less frequent and shipping channels slowly begin to recover. In other markets, demand has been steady and logistic bottlenecks and supply disruptions in certain regions continue to create extremely tight conditions. In addition, we're in the middle of the traditional major maintenance season, and on planned downtime, including our stand-up mill fire, continue to put upward pricing pressure on all markets. For lumber markets, pricing has been mixed, but on average, they were higher in the quarter when compared to Q1. While housing starts have begun to diminish, homebuilder sentiment remains positive, and we believe the midterm backdrop for U.S. lumber pricing conditions remains positive, with relatively low housing inventory, strong housing expectations supported by recent statistics, and constructive homeowner demographics, today market volatility is the result of rising borrowing costs, construction constraints from inflexible supply chains, labor and home construction supply shortages, and inconsistent lumber supply from Canada. We expect European lumber prices will moderate in Q3, while the US market hit a floor early in July and has since been modestly strengthening. We will continue to optimize our mix of lumber products and customers. In Q2, 46% of our lumber sales volumes were in the US market, with the majority of the remainder of our sales in the European market. We believe our logistics strategies give us a competitive advantage However, we experienced some freight cost increases in Q2. This is primarily the result of higher fuel costs, increased jobs of trucking, along with higher warehousing costs in North America due to the limited availability of rail cars. Railways are struggling with labor shortages caused by the pandemic. We're seeing improvements, but the lack of rail car availability will likely persist in the near term. as the railway continues to work through its shipping backlogs and labor issues. In Germany, we continue to see strong demand for both pulpwood and saw logs. Much of the increased demand for pulp logs is being driven by pellet manufacturers. Russia's war in the Ukraine is behind European energy concerns and is pushing energy prices up and creating more demand for wood-based heating solutions. Currently, solid demand and supply appear to be in balance, but we're expecting upward pricing pressure for pulpwood in Q3. In Western Canada, as expected, increased harvesting activity has helped ease pricing pressure, and as a result, we expect modest downward pricing pressure in Q3. We have an aggressive CAPEX program in 2022. The majority of these investments are focused on high return projects that will drive new product development, ESG advances, productivity improvements, and input cost reductions. Two of the larger projects, the new woodrooms at Selgar and Peace River are progressing, but have begun to slip from project schedules due to delays in delivery of key pieces of equipment. These projects will generate high returns for us and have considerable carbon reduction attributes, so we remain committed to them. and we will be pushing hard to have them commissioned this winter. We're making good progress on investments in our German wood procurement infrastructure that will add to our competitive advantage, and the new sorter at our freestyle mill is on schedule and will maximize the benefit of our new planer by allowing for even greater grade differentiation. And while most of the Stendahl 740 pulp expansion project was completed, in the spring and running as expected, we will complete the final element, some modest modifications to the pulp machine wrapping line in the fourth quarter. In keeping with our carbon reduction strategy, we're developing a lignin development center that will include a lignin extraction pilot plant. The pilot plant will employ a leading-edge technology that would allow us to look at commercializing derivatives of lignin. We also commence construction on a $27 million expansion project at our Spokane mass timber plant, which I expect will be a first phase of investment as we look to grow this business. This phase one project will allow this state-of-the-art facility to fully utilize a more varied raw material mix and increase finger joint production. This is a first step in what will ultimately be an expansion of CLT capacity. a preparatory step we're making while we steadily increase our order book for mass timber elements, which we expect to materialize in sales in 2023. We remain satisfied with the pace of the ramp-up of this business, which we expect will continue for several more quarters. And now, a quick update on the Stendhal fire. As most of you know, we took the Stendhal mill down July 1st due to a fire in our woodyard, specifically the automated inventory and reclaimed bunker. While the fire was quickly and safely extinguished, it has taken us a number of weeks to assess the damage and determine the best approach to safely return the mill to full production. It now appears that there is considerable damage to certain overhead conveyor systems that will take several months to repair. However, we have developed a temporary solution to bypass damaged elements of the system and restarted the mill earlier this week on a reduced production level. Over the next few weeks, we expect to optimize this temporary process with an objective of returning the mill to as close to full capacity as possible. We're also currently working with suppliers to plan a permanent repair of our fully automated system. Our property damage and lost business damages are covered by insurance subject to normal deductibles, and we will be settled in due course. As we think about climate change and the rapid shifts occurring regarding carbon, products like lignin, mass timber, green energy, extractives, lumber, and pulp are all products that will play increasingly important roles in displacing plastics and carbon-intensive products. Products like concrete and steel for construction, plastic packaging, fossil fuel generated electricity, and synthetic fragrances and flavors, even synthetic textiles, all products that are releasing carbon or ending up in our oceans and our food chain. As you may have seen from our recent press release, we're pleased to have published our 2021 sustainability report. The report highlights not only our ESG performance and midterm objectives, but why we believe that our low-carbon, low-pollution products are part of a solution to the global carbon challenge facing our generation. Finally, I'm excited about the potential of our recently announced acquisition, Pulse Industry Torgau. This acquisition will be accurate immediately, and it advances our long-term strategy of growing our business in solid wood products and diversifying our revenue streams. We have entered into an agreement to acquire all the outstanding shares for 270 million euros, including working capital that we're estimating to be about 43 million euros. This facility has an annual lumber production capacity of about 410 million board feet, an addition that will push our total number capacity to almost 1 billion board feet. Most of the Torgao production today is being used as feedstock for highly automated pallet plant. The plant is the world's largest producer of European Pallet Associated, or EPAL, wood pallets, with the ability to produce 17 million pallets annually. In addition, the facility can produce up to 150,000 metric tons of wood pellets, 85,000 metric tons of wood briquettes, 136,000 million board feet of mill lumber products, and 90 gigawatts hours of electricity. The synergies of the business with our existing pot mills and saw mill are compelling, and we estimate to be in the range of $16 million annually, most of which will be in place within six to 12 months of closing. The synergies arise from our intent to optimize lumber production, drying, planing, and grading between Torgau and Friesau. And on the input cost side, we see opportunities to optimize wood chip and residual deliveries between Torgau, Rosenthal, and Friesau. According to the sellers, Torgau generated 68 million euros of adjusted EBITDA in 2021 on sales of 227 million euros. And for the three months ended in March 2022, the business had already generated 22 million euros of EBITDA. This acquisition is subject to a customary governmental competition review before we will be able to close on the purchase, which we expect to occur in about two months. We will have more to say about this business when we close in late Q3 or early Q4. Thanks for listening. And I will now turn the call back to the operator for questions. Thank you.
spk10: Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. A voice prompt on the phone line will indicate when your line is open. Please state your name before posing your question. Again, press star 1 to ask a question, and we'll pause for just a moment to allow everyone an opportunity to signal for questions.
spk09: And we'll take our first question. Please go ahead.
spk06: Hi. Thanks for taking my question this morning. In regards to the Torgau acquisition, do you guys have any idea on how much capital spend is planned for any upgrades to the sawmill after you close the deal?
spk01: In terms of capital expenditure at Torgau, we're working based on the plan that they had already put in place. So we're following their CapEx plan as is. Obviously, we'll be looking at expanding all the potential synergies that we have already identified as part of this acquisition. We will continue on the plan that they have set up for ourselves. Obviously, we will keep on looking for opportunities to even go beyond that as we develop that mill further.
spk06: Okay, great. Thank you. Just a quick follow-up. In Europe, how do you think the natural gas shortages are going to impact industry-wide production over H2 for your paper customers and then also for Mercer as well, and I'll leave it there.
spk01: Yeah, naturally one of the biggest concerns that everybody has right now are precisely those gas shortages in Europe and what we may see in the coming weeks and months with this conflict with Russia and how that will develop. From our own perspective, we're very well equipped to deal with such shortages. Only one of our equipment is consuming natural gas, but we've made the adjustment necessary for those equipment or that equipment to be able to take other types of fuel in an event of a shortage. However, we are realized that for customers in the paper business as well as even some chemical suppliers may have considerable issues when it comes to gas shortages. So we're obviously in the lookout for those. While we remain cautious about the environment, we realize that this is obviously an important risk that we all face in the industry going forward.
spk06: Great. Thank you so much.
spk10: And we'll take our next question.
spk09: Please go ahead.
spk08: Hello, can you hear me?
spk02: Yeah, Kasia, is that you?
spk11: Yeah, sorry, I wasn't sure if it was me in the queue. I didn't hear my name. We hear you loud and clear. Excellent. Great. A couple questions for me. First, just back to HIT. What's the production plan there? Basically, around how much percentage of the production do you envision going forward being actual pallets versus the commodity lumber? And do you guys expect to get basically up to the 410 million board feet?
spk01: Well, obviously we want to make sure that we optimize the production capability that HIT offers. That has been our intent as we were looking into this project. They run a very significant pallet operation, as we mentioned before, with 17 million capacity. But one of the things that we want to make sure is that we optimize the log usage in that facility. So that is precisely some of the synergies that we are wanting to explore, how much more lumber we can extract out of it at a higher premium versus the pallet business. So that will be part of the work that we will be conducting as we initiate operations there.
spk11: Great. Thanks for that. So just reading between the lines there, it's conceivable that the majority of the production will be focused on lumber then versus pallets at some point?
spk01: It's too early to say that it would be switched to more lumber than pallet. Again, since pallet is such a significant component of HIT, that would not necessarily be a quick transition to make. But again, the thing is, how do we optimize value from that facility? And we'll get to that point as we take ownership of the facility.
spk11: Gotcha. Appreciate that. So perhaps this next question is a bit moot, but I'll ask anyway. Do you have any sense of how much of the production from hit you expect will eventually be shipped to freeze out then for planing and drying?
spk02: Yeah, it'll really depend on how much we, how much, as Juan Carlos was saying, how much of that volume we shift into dimension lumber or market lumber and away from pallets. But I would say a considerable volume. If we do switch, a considerable volume will go to freeze-out because at freeze-out, you'll remember, we've got the tremendous sorting capacity there. We've got a brand-new planer there. We've got the grading capability, the automated grading and the grade stamp, so I think it's reasonable to expect that a pretty large portion of that lumber would end up going through FreeSow.
spk01: Plus, we also have unused planer capability at FreeSow that obviously will give us the opportunity to transfer that to HIT so that we can do planing in HIT as well. So that's part of the synergies that we see given where we are with FreeSow.
spk11: Gotcha. Thanks to you both for that caller. So just switching gears now maybe. You mentioned, I believe, I don't know if I just heard, but $27 million for the CapEx for Spokane to expand the capacity there. Maybe just confirm that that's the right number that I heard and then timeline for how that will be spent or when that will be spent and then potentially increase that funding down the line. I think you mentioned that was phase one, so presumably there's a phase two at that point.
spk01: Yes, you are correct. That is the amount that was approved recently, and it's already being spent. It's equipment that is already being ordered. And that's, as I mentioned when I was talking about it, that's the first phase of a project that would allow us to expand our CLT capacity, expand our glulam capacity, and give us more capacity also in terms of finger jointing. So it will allow us to actually make a broader and stronger portfolio out of the Spokane facility. In terms of timing of that, obviously we're looking at equipment being manufactured and delivered to us for this first phase, equipment that will be ready next year. And obviously we'll get into the second phase probably before the year closes so that we can get this full... array of benefits in the coming years.
spk11: Thanks for that one, Carlos. And then just on Stendhal, is the intent to run that around 80% in the near term? And then what's the timeline for getting that back to full capacity? Are we talking months or is it next year? And then if you have any sense of when you expect the business interruption insurance proceeds and capital proceeds as well, that would be helpful.
spk01: In Stendal, we've obviously, as we mentioned before, the team have done an excellent job in getting that mill up and running again. It's important to reiterate that the damages were limited only to the woodyard. There was no effects at all at the mill facility as such. In that regard, we've done the changes and the necessary temporary solutions to make sure that we can feed chips to the mill. When we're running the mill right now, between 50% capacity, we look into ramping it up probably to 60% later this month, and ultimately going to 80% and getting as close as possible to full capacity. So it's a slow process. It's not something that happens overnight, but the team is committed and we're doing things in a proper way. So yeah, we expect by the end of this quarter that we will be at least around 80% capacity running on the mill.
spk11: That's really helpful, Giselle. Thank you very much for that. And Dave, do you have any sense of when the business interruption insurance proceeds might come in?
spk02: Yeah, it's probably several months away, Cassius, so if you might imagine, we will want to be, to the extent that we don't get to 100%, even if we only get to 95%, there'll be a business interruption claim there. So it'll take us several months, as Juan Carlos was saying, to correct, to reconstruct the automated reclaim process. So we'll wait until after that's complete before we do the full final insurance claim. So I think we're talking several months.
spk11: Perfect. Thanks to you both for all the detailed replies. It's super helpful. That's all I have. I'll get back in the queue. Happy Friday. Enjoy your weekend.
spk02: Thank you. Thanks.
spk10: As a reminder, it's star one to ask a question. We'll take our next question from Roger Spitz with Bank of America. Please go ahead.
spk03: Hey, good morning. There's several questions on HIT. First, is Pallets a particularly seasonal business or at least a sale of them in Europe? Or perhaps you can comment the Q1-22 EBITDA of $22 million is clearly well above the 2021-68 on a run rate basis?
spk01: Yeah, HIT has done a very good job over the past few years to improve their operations. Obviously, they've enjoyed also very favorable market conditions like most of us in the lumber industry have faced. In terms of their pallet business, they remain the largest European pallet producer, so they're still in high demand. With the crisis in Russia and Ukraine, which are also sources of pallet manufacturing, obviously that constrains supply from that angle. So there's still some tailwinds, if I can put it that way. as we look into the pallet business itself and the demand for them going forward. So in general terms, I would say that the prospects for the pallet business are positive in the short and medium term.
spk03: Great. And do you have a sense of, in Europe, what the split is between wood pallets and plastic pallets? And if there has been a trend of a shift from one of the substrates to the other substrates? I don't know if they use plastic pallets over there like they do over here, but I presume they do.
spk01: We know most of it is the EPAL pallets that we're working at. That's the majority of the European market, much more than the plastic ones.
spk03: Okay, so that's not really a risk factor there. So you're going to finance this 100 million euros out of the expanded... facility over there, bank facility over there. Would the other, say, $180 million or plus come from cash, or do you have any other thoughts on how you might want to finance that, either short-term, immediately at closing, or term some of that out?
spk02: No, you've got that exactly right, Roger. That's our intent, is the balance would be cash.
spk03: Okay, perfect. And then lastly, I'm sure you use green liquor to fire, but you do buy natural gas, mainly for your lime operations. How much nat gas are you purchasing in Germany, and do you hedge that, and if you do, how are your hedges working over there?
spk02: Yeah, we haven't typically disclosed how much gas we're purchasing, but I can tell you that we do buy forward to the extent that we can. So we're well into a year and a half out for a large portion of the gas that we purchase in Europe. So while we're not getting the spot prices that you see out in the market today, because we're not fully bought out, we are seeing a fair bit of inflation on gas but it's not nearly just to give you a sense it's not nearly the same as the the electricity benefits that we're gaining on the top line the revenue the gas is a pretty small pretty small component of our total energy profile oh it is okay that was my next question perfect they've appreciate it very much thank you you're welcome thanks
spk09: And we'll take our next question from Andrew with Credit Suisse. Please go ahead.
spk08: Thanks. Good morning.
spk04: Juan Carlos, since you've been on board, it's been obviously pretty busy for you. But maybe if you could give us a public view on how you think of the future business mix for Mercer and just the company positioning.
spk01: Absolutely. Thank you for the question. Yeah, it's been almost three months with a lot of things happening at Mercer, a lot of moving parts, but all in all, very much in the right direction when we look into our future growth prospects, when we see the situation at our lumber business growing, the HIT acquisition that sets up in a very different trajectory to growth. So we see a very bright future in that regard. The investment that we just announced also in Spokane that allows us to increase tremendously our potential out of the CLT facility in the U.S. for a very high growth market, those are all very significant prospects for our business. And in the meantime, we continue to obviously invest in our pulping facilities and make sure that we can extract more value from them. But beyond that, I think the other important component of this whole thing is how we start investing stronger in our future, in innovation. This initial investment in the pilot facility for lignin in Rosenthal is one of the important steps to that direction. And that is something where we will see ourselves spending more and more time as we start to envision what are the potential market opportunities that we will have in that space and the investments that should be then happening to make sure that we have the right capacity to take advantage of such market possibilities. And also, even beyond lignin. We were going to look at, from a wood chemistry perspective, everything that we will be able to extract from our natural resources to make sure that we can come up with high-value added products that will have a positive impact from our environmental point of view. So those are kind of the big drivers for the business. But we continue to put a very strong emphasis on all the sustainability aspects that we're working so hard on, as were highlighted in the sustainability report. So I guess in a nutshell, that's where we're working on and that's where our focus is.
spk04: That's very helpful for color and context. And I guess maybe just reinforcing that, if you think about just the diversity of operations that have been built up and continue to build, Do you feel that you've got a greater diversity of cash flows and maybe more stability of cash flows, but still leaving that upside potential on some of the more cyclical businesses?
spk01: Yeah, and obviously one of the benefits of expanding this lumber business is a little bit of the counter cyclicality that we see with pulp prices. So we managed to ease a little bit of the peaks, the low and high peaks that the pulp business is so accustomed to. I think that makes that curve a lot more soft on the edges and allows us to have a much more steady level of profitability as we move forward. I think that's an important part of the equation, make sure that we reduce that volatility that we know the pulp is subject to. So that's a big part of it. And obviously keeping an eye on the future because when we look at at these other markets that we will be exploring with lignin and so forth, those are obviously driven by very different elements depending on the end uses that will be identified for them. So it's all about that diversification and making sure that we can run better the different waves that we see in the microeconomic aspect.
spk04: I appreciate that. If I could sneak one more in, and it's really for David on fiber costs. and just how you think about where you are now in Germany and just the outlook. And I asked the question kind of in part is if we think of the energy balance that exists in Europe right now. And if we look back in the past, there was a point in time when, you know, the pellet market took off and there was some pressure on fiber pricing. I just, if you could just give us maybe a view on where you are now and the outlook that you have.
spk02: Yeah, no, you're right on, Andrew. You might remember back in 2013, we had a similar, not a war in Ukraine, obviously, but similar escalation in energy costs. And that impacted the pellet costs, the heating pellet costs. And heating pellets are a competitor to our pulpwood costs. So as you'd expect, over the last two quarters, we've seen considerable inflation on our pulpwood costs, not so much on the saw logs, but on the pulpwood costs. At the moment, we're seeing some further modest inflation in Q3, but we don't believe it'll be to the same rate that we experienced in Q1 and Q2, which is really when the gas price went up so quickly.
spk04: And if I can just sort of sneak this one in, I know I'm sneaking in more questions, but I guess you have freeze out this time, and your operational setup is just different than it was back in, say, 13.
spk02: Absolutely. And I think, like I was saying, the saw log cost has been – it went up considerably last year in 2021, but in the recent couple of quarters, the increases have been modest – And of course, as you pointed out, that gives us quite a big advantage. We're producing a lot of wood chips, a lot of residual wood chips out of that sawmill, which are going just down the road to Rosenthal. So we're much less exposed to the pulpwood costs that we would have been, say, five years ago. That's exactly right.
spk04: Okay, that's great. Thank you very much.
spk02: Yeah, and I'll just add, Andrew, This is one of the compelling synergies of the HIT acquisition as well. So you can imagine this is a sawmill that today we're not getting any of those residuals from that mill, but in the future we'll start directing those wood chips in particular, those wood chips It's about 100 miles down the road. We'll start directing those wood chips to the Rosenthal pulp mill. So this is building on a synergy that we started with the Friesau mill and we plan on continuing with the Torgau mill.
spk01: And to add to it, and it gives us also the possibility to, the other way around, sawdust from our operation in the different mills then sent back to HIT as they obviously have a big pellet and briquette business going on. So we have full use of every single aspect. That's the whole point of optimizing the operations when we look at our four units in Germany being so close.
spk00: Thank you.
spk10: We'll take our next question from Jeff Gates with Gates Capital Management. Please go ahead.
spk08: Yeah, this is Jeff.
spk07: I'm wondering, are there any other new businesses beyond what you mentioned that would get you into any more specialty products than the commodity products that you're in? And then secondly, once upon a time, this company paid a much higher dividend as a percent of its equity cap. And I'm wondering if you would... considering any changes in dividend policy going forward.
spk01: So, Jeff, let me address the first part of your question. I'll leave the second one for Dave. We're obviously continuing to look for opportunities to diversify our business and to make sure that we can capture higher value for products that come out of our forestry assets. So that's a permanent way of operating for us. Obviously, our focus right now is on making sure that we extract the highest value possible of the recent acquisitions. And Spokane CLT and now HIT obviously will be a driving force for us. And we have differentiated products there where we believe that we can extract a significant amount of value. That's why we've decided to make that investment in Spokane, and this Phase 1 that I talked about, and soon to have a Phase 2 to complement it, because it's all about having higher-value products, specialty products that can position us very well in that spectrum. So we'll continue, but in the meantime, we will always continue to look for other opportunities that may arise. and time them properly. It's obviously important that we do this in order so that we can capture the synergies, we can capture the value, we can concentrate our resources, and then when the time is right, move on to the next possibility of keep on growing our business in a solid way.
spk02: And maybe just a couple of comments about the dividend. You're right. In the past, we've had a considerably higher dividend. And you'll remember that we dropped it down modestly at the beginning of the pandemic. And I can tell you that the board, this is a topic at our quarterly board meetings. It's a heavy topic that is discussed and debated within our board. And the general discussion is it's always a balance between CapEx the CapEx program that we have underway M&A opportunities that we may have in the in the funnel and of course some return to to shareholders and at the moment the board is viewing the the acquisition the M&A acquisition and the high return CapEx particularly at Spokane at the moment and finishing off the other projects that we have at Peace River and Selgar the board is viewing that those as better returns for shareholders and at the moment. But I think the board has got to be careful not to get ahead of our board here, but they have an interest in watching the dividend and they have an interest in increasing the dividend over time. But at the moment, they want us to focus on the acquisition and finishing off this high return CapEx.
spk07: And then my last question is, you know, I think pro forma you'll be around 900 of net debt and your equity is a billion one. And I'm just kind of wondering, you know, I know you have leverage ratios, et cetera, but there's also, you know, considerations by investors when they look at your cost of capital and, you know, how much is debt and how much is equity and you are cyclical. So have you guys given any thought over time to, But considering a somewhat lower leverage in terms of net debt versus your equity cap, that might give you more optimal cost of capital and a better equity cost of capital.
spk02: Yeah, that's something we consider. And I think if you went back historically, and you don't have to go back too far to see that we were We used to carry much more leverage when compared to the EBITDA generation of the company. I think you'll see going forward that we'll be targeting lower levels. So at the moment, we're below two on a net debt basis. And we think once we get to the Torgau operation under our wings, that'll be reduced further. So I think You could see us targeting, we'll start talking about targets that are lower than we've had in the past. So I think we understand what you're saying and don't disagree with it. We'd like to have, there's times that we would take that leverage a little bit higher if we came across a really great acquisition or great opportunity, but mid-cycle, long-term, the goal is to push the leverage a little bit lower.
spk08: Okay, thank you.
spk09: We'll take our next question from Paul Quinn with RBC Capital Markets.
spk10: Please go ahead.
spk05: Yeah, thanks very much. Morning, guys. Just a question for Juan Carlos. You've been at Mercer here for a little bit. Maybe you could just take a high-level overview of what you've seen on the pulp side as well as wood products, what you like, what you think needs to be rethought or maybe some issues around.
spk01: Absolutely. Well, it's been a great few months getting to know our operations. I've been around all our facilities. in Germany, in Canada, in the U.S. And one thing that strikes me from the get-go is that we have very good facilities overall. Our mills are well positioned. They're highly competitive. The teams in place are working on the right projects to make sure that we extract more and more value from them. We have a pipeline of projects that have been identified by the local teams that will allow us to extract much more value from all of these facilities, absolutely. So it's a very good platform to grow from, a very solid platform in Germany, very well positioned and taking advantage of the synergies that having pulp mills close to sawmills give us. This is obviously something that strikes first hand as something that gives you a tremendous competitive advantage and something that obviously was the reasoning behind the HIT acquisition as we saw that as something that was really, really strategically important. And also, even more considering fiber supply shortages in future, future years, that we need to make sure that we're properly prepared for those. And this gives us that strength of dealing with any fiber shortages that might come in the out years. So that's also very looking forward into making sure that we have a sustainable business, a sustainable fiber supply. So that's very well organized in the way that the company has been set up. In Canada, I think we have two assets that have a tremendous potential for growth. There's a lot of work in progress. You see the two woodroom CAPEX projects that are being run right now are strategic for us, not only from a profitability perspective, but also from an environmental perspective. Those are very positive additions. and we continue to see even more potential opportunities to improve our businesses there. The facility in the U.S., in Spokane, is a top-notch facility. That's a state-of-the-art facility right there, and the possibilities are just tremendous. That's why we've decided to invest further in it and make sure that we have a much more complete and a different portfolio, because once we're able to have Glulam there, together with CLT, that puts us almost in a unique situation when you look at what other companies are able to offer that type of combined product portfolio out of one facility. So it's all accurate in that sense that we believe that there's a lot of value to be extracted from those. And not to say enough about the future possibilities. This lignin plant that we're putting in Rosenthal, this pilot plant, that's just the beginning. And remember, this is a pilot facility only, so this is not going to be the end point for us, but just the starting point. and proving that capability, proving that production ability would allow us to see where else we would be able to go in a more commercial stage with such type of extraction possibilities, not only Rosenthal but in some of the other mills. So I think there's tremendous opportunities here that we will be looking forward to, and I think that's thanks to the fact that we have good assets to work with.
spk05: Okay, great. Thanks for that overview. And then maybe just talking about that, you know, your pilot facility on LinkedIn, you know, I cover a few names that have gone down the biomass product route in the past, you know, five or 10 years and never really seen any kind of you know, metrics coming out of those investments that are over the cost of capital. What do you think now is different? Are we at a point in reflection where, you know, some of these products are actually going to be very commercial and there's upside, or is it more of a diversification strategy, you know, for Mercer?
spk01: Well, breaking ground on some of those innovations is obviously a lengthy process. And while everybody expects to see returns very, very quickly, when it comes to innovation, those things take time. So the companies that have invested in lignin or other byproducts are obviously have been working on it for several years. And I think those results will soon be much more visible as those markets are fully developed. These are new products that end up substituting fossil-based products. So it's not only the fact that you have to manage to produce a high-quality product, but also the fact that you need to substitute an incumbent in those spaces. So that obviously takes time to develop. But once that ground is broken, I think we'll see a significant increase of demand. of volumes and this business will in fact grow to a much higher degree than what it is right now. I agree with you that right now it's not seen clearly and a lot of talk but very little numbers to show in any significant way by any of the companies that have been playing in this before. But I think that's part of an absolute normal process when it comes to these kind of innovations. You need to break ground. And once those markets are settled and once those products are well known and accepted, then just the market opportunities just opens up.
spk05: Okay. And just finally, who do you consider a best-in-class company around biomass product?
spk01: Can you repeat that again? Sorry, I didn't get the question.
spk05: Who do you consider as best in class in terms of a biomass product company besides Mercer?
spk02: You mean biomaterials, Paul?
spk01: Sure. Well, there's – I mean, I wouldn't know how to answer that question. I think there's – There's different types of approaches by different companies, and I wouldn't single out anyone in particular. I think there's different... Some are trying the lignin route. Some are trying other specialty fibers out, other types of cellulose products. So I wouldn't be able to single out one in particular, to be honest with you. I think everybody's trying a different route, and some are also joining the lignin run. But we'll see how that develops over time.
spk08: Okay. Fair enough. Best of luck, guys. Thanks.
spk09: It appears there are no additional questions at this time.
spk10: I'd like to turn the conference back to Juan Carlos Bueno for any additional or closing remarks.
spk01: Okay. Thank you, operator. And thanks to all of us for joining our call. Dave and I are available to talk more at any time, so please don't hesitate to call one of us. Otherwise, we look forward to speaking to you again on our next earning call in October. Bye for now.
spk10: This concludes today's call. Thank you for your participation. You may now disconnect.
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