Mercer International Inc.

Good morning and welcome to Mercer International's first quarter 2024 earnings conference call. On the call today is Juan Carlos Bueno, Mercer's President and Chief Executive Officer, and Richard Short, Mercer's Chief Financial Officer and Secretary. I will now hand the call over to Richard.

Thanks, Liz. Good morning, everyone. Thanks for joining us today. I will begin by touching on the financial and operating highlights of the first quarter before turning the call to Juan Carlos to provide further color into the markets, our operations, and our strategic initiatives. Also, for those of you that are joining today's call by telephone, there is presentation material that we have attached to the investor section of our website. But before turning to our results, I would like to remind you that we will make forward-looking statements in this morning's conference call. 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, our EBITDA was $64 million compared to Q4 EBITDA of $21 million. The improved results were driven by not having any major maintenance downtime, improving pulp sales realizations, and lower fiber and other production costs. Our pulp segment contributed quarterly EBITDA of $68 million, and our solid wood segment EBITDA was negative $1 million. You can find additional segment disclosures in our form 10-Q, which can be found on our website and that of the SEC. In Q1, both our NBSK and NBHK sales realizations increased compared to Q4. Average list prices increased in Europe and North America due to stronger demand and global supply constraints. In China, prices were flat as demand slowed during the Chinese New Year and picked up near the end of the quarter. The European MBSK list price averaged $1,400 per tonne in the current quarter, an increase of $155 or 12% from Q4. And the North American MBSK list price averaged $1,440 per tonne in the current quarter, an increase of $128 or 10% from Q4. In China, the Q1 average MBHK net price was $662 per ton, up $19, or about 3%, compared to the Q4 average price, resulting in the market price gap between MBSK and MBHK in China narrowing to about $83 per ton in Q1 from $105 per ton in Q4. The North American NBHK average Q1 list price was $1,223 per ton, up $140 or 13% from Q4. Total pulp sales volumes in the first quarter increased by 75,000 tons to 566,000 tons, driven by the timing of sales and higher production due to lower scheduled maintenance downtime. We had no scheduled maintenance downtime in Q1 compared to 23 days of downtime in Q4, which positively impacted Q1 EBITDA by about $23 million when compared to Q4. After adjusting for the Q4 planned shuts, pulp production was essentially flat from the fourth quarter. For our solid wood segment, we had modest lumber pricing improvements in both Europe and the U.S. market. Despite the price increases, overall lumber demand remained subdued as a result of uncertain economic conditions in Europe and high interest rates. The random length U.S. benchmark for Western SPF No. 2 and better was $462 per 1,000 bore feet at the end of Q1, compared to $422 at the end of Q4. Today, that benchmark price for Western SPF No. 2 and better is around $421 per 1,000 bore feet, virtually unchanged from the beginning of 2024. For Q2, we are expecting generally flat lumber prices in the U.S. and European markets as demand remains weak. Lumber production was a near record, 127 million board feet in Q1, up 14% due to seasonal downtime in the fourth quarter. Lumber sales volumes were 121 million board feet, up 8% from Q4. Electricity sales totaled 259 gigawatt hours in the quarter, which was about the same as Q4. Pricing in Q1 modestly decreased to about $94 per megawatt hour from $98 in Q4 due to lower spot prices in Germany. In Q1, our pulp segment had lower fiber costs, and Q4's supply remained stable. On the other hand, our solid wood segment had higher saw log costs due to strong demand in Germany. Production for our solid wood segment's mass timber operations decreased in Q1 from Q4 due to minor customer-driven delays for certain large-scale projects. These projects are now underway, and we are satisfied with the order book today. In the first quarter, we made the strategic decision to dissolve the Caribou Mill joint venture, which resulted in the recording of a non-cash loss of roughly $24 million, or 35 cents per share. We expect the transaction to only have a nominal impact on 2024 EBITDA. Wong-Kar also had more to say on this in a moment. We reported a consolidated net loss of $17 million for the first quarter, or $0.25 per share, compared to a net loss of $87 million, or $1.31 per share in Q4. We consumed about $40 million of cash in Q1 compared to $30 million in Q4. The large cash usage in Q1 was primarily due to higher receivables, which were up roughly $64 million, driven by higher sales realizations and sales volumes. We expect the majority of this working capital bill to reverse in Q2. At the end of Q1, our liquidity position totaled $555 million, comprised of $274 million of cash and about $281 million of undrawn revolvers. Finally, our board has approved a quarterly dividend of 7.5 cents per share for shareholders of record on June 26, for which payment will be made on July 3, 2024. That ends my overview of the financial results. I'll now turn the call over to Juan Carlos.

Thanks, Rich. Our Q1 operating results improved significantly relatively to Q4. The improvement was primarily the result of higher pulp prices in combination with no major maintenance at any of our mills. And our results in Q1 also benefited from lower costs, including fiber and energy costs. Overall, All of our mills ran at near record production levels, while both our energy production and sales volumes were at record levels in Q1. As previously announced, we came to the decision to dissolve the Caribou Mill joint venture after reviewing this asset and its future prospects against the strategic priorities and determined that dissolving the joint venture will allow us to focus our resources to areas more aligned with our long-term strategic goals. I will also add that we were not expecting Tarigu to have any meaningful impact on our 2024 earnings. In Q1, we invested roughly $18.5 million in our operations. This CapEx spending was in line with our 2024 CapEx target of between $75 to $100 million. Those of you who follow the company closely will recognize that our 2024 CapEx target is well below our traditional spend. Our 2024 CAPEX target is essentially a maintenance of business budget and is the result of our weak cash flow generation in 2023. I will speak about our markets in a moment, but we're optimistic about our cash flow generation in light of improved pulp pricing expectations for the remainder of the year. Consequently, we are comfortable restarting our Togau lumber expansion project and the Spokane sorting line project. Both of them will provide significant added value and were originally contemplated as part of our investment strategy for each mill. We have also approved a handful of other small value-adding projects, and as a result of these decisions, we now expect our CapEx to be between $95 to $120 million in 2024. We will also continue to manage our working capital and costs closely. Despite our improved outlook for 2024, we believe the recovery for all our markets will be gradual. Overall, pulp markets have improved significantly in the quarter, with both European and North American markets showing the most improvement and China lagging a little bit. We're seeing strong demand from European paper and tissue producers, and this demand is primarily the result of merchant destocking and logistical challenges around Chinese imports. To a lesser extent, we are seeing demand increases in North America as well. This strong demand is exacerbating the impact of the permanent closure of NBSK mills in the last two years, while the impact of the Finnish transport strike and the significant unplanned downtime of one of Finland's largest mills are also adding to the supply challenges. Looking forward, we expect upward pulp price pressure through the second quarter. In addition, pulp markets may face an even tighter supply situation Should the Canadian railway unions take labor action as they are currently threatened to do? We're implementing mitigation strategies, but ultimately, should this labor action be significant, it could negatively impact our ability to get our Canadian mills products to market. Our mills run at near record levels in the quarter. When comparing our first quarter production to Q4, remember that Celga took a 22-day major maintenance shot in Q4 of last year. and Stendhal took a one-day maintenance shot, while in Q1, we didn't have any at all. Our remaining major maintenance downtime for 2024 is as follows. In Q2, Peace River already has taken their 16-day maintenance shot in April. This shot was extended by two days due to found work. In addition, Stendhal will take a long 17-day shot. Combined, this downtime equals to roughly a loss of about 61,000 tons of production. In Q3, Rosenthal will have a 14-day maintenance shut, and Selga will take a short four-day mini-shut, which will amount to about 20,000 tons production loss in total during Q3. As a reminder, Selga has moved to an 18-month major maintenance schedule and will not have a major maintenance shut in 2024. Our solid wood segment results although improved compared to Q4, are still not where we expect it to be. The U.S. and European lumber markets were up slightly. However, high interest rates continue to weigh on housing starts and construction in general. We see the potential for lumber pricing improvements in Q2, but generally expect pricing to stay flat with any improvement likely linked to improved economic data. We recognize there may be some short-term pricing upside due to recently announced lumber production retirements. or the realization of a prolonged Canadian railway strike. That said, we continue to believe that low lumber inventories, the large number of sawmill curtailments, relatively low housing stock, wood shortages created by recent Canadian forest fires, and homeowner demographics are still very strong fundamentals for the construction industry, and this will put sustained positive pressure on the supply-demand balance of this business in the midterms. We continue to optimize our mix of lumber products and customers to current market conditions. As such, in Q1, 43% of our lumber sales volume was sold in the US market with a remainder sold in European and other markets. Shipping pallet market remains weak due to an overall weak European economy. Once the European economy begins to show signs of recovery, we expect pallet prices to return to normal levels allowing our Torgal assets to deliver significant shareholder value. Heating pellet prices were down in Q1 due to expected seasonality in this market. In addition, the integration of the recently acquired mass timber assets continues to progress very well. We now have roughly 35% of North American mass timber production capacity, a broader range of product offerings, and a much larger geographic footprint, which gives us competitive access to the entire North American market. We continue to see strong customer interest in our Mastinburg products, which has allowed us to build a significant order file. At the end of March, our order file totaled about $80 million. As I previously noticed, we are in the process of restarting strategic and high-return CapEx projects at both Torga and Spokane mills. The Torga project is focused on the mill's wood yard and log-in feed systems. Once completed in the late 2025, this project will allow the mill to produce more high-quality dimensional lumber. This project was originally envisioned as part of our investment strategy for this mill, and we're looking forward to completing this work while lumber prices are in cyclical lows. Similarly, the Spokane project is focused on the mill's wood infeed and sorting processes. Once this project is completed in mid-2025, the mill will be able to source lower-cost feedstock and process it into high-quality lamb stock. Ultimately, this will significantly reduce the mill's fiber costs. In Q1, our overall pulp fiber costs decreased from Q4. In Germany, a steady supply of sawmill chips resulted in modest cost decreases, and in Canada, a ramp-up of Peace River's woodroom and our cell guard wood strategy also pushed our fiber costs down in Q1. Looking ahead, we expect further modest declines in pop wood costs at our mills in Q2, but we expect a slight increase to our saw log costs due to strong demand. I am pleased with our new Lignin extraction pilot plant ramp-up and the partnerships we have entered into to support the future commercialization of this product. As a reminder, this new lignin plant is a large step towards Mercer being able to develop a portfolio of novel offerings before going commercial with it. We're excited about the future prospect of this product as a sustainable alternative to fossil fuel-based products, such as in adhesives and advanced battery elements, to name only a few. This aligns perfectly with our strategy, which involves expanding into green chemicals and products that are compatible with a circular carbon economy. As the world becomes more sensitive to reducing carbon emissions, we believe that products like lignin, mass timber, green energy, lumber, and pulp will play increasingly important roles in displacing carbon-intensive products. Products like concrete and steel for construction or plastic for packaging. Furthermore, the potential demand for sustainable fossil fuel substitutes is very significant and has the potential to be transformative to the wood products industry. We remain committed to our 2030 carbon reduction targets and believe our products form part of the climate change solution. In fact, we believe that in the fullness of time, demand for low-carbon products will dramatically increase as the world looks for solutions to reduce its carbon emissions. We remain bullish on the long-term value of pulp and are committed to better balance our company through faster growth in our lumber and mass timber businesses. In closing, I am pleased that our pulp markets are recovering a little more quickly than expected, and the fact that this improvement is giving us the confidence to increase our planned 2024 capital spend, which will allow the benefits from these key high return projects to be realized even sooner. We also expect an improved result from our solid wood business in Q2. As a reminder, we have an unusually heavy schedule of major maintenance in Q2, which will be a drag on what we're expecting will otherwise be a strong financial quarter. We will remain focused on our cost-saving initiatives, and we will also continue to work on rebalancing our assets in line with the execution of our strategic plan, and we'll continue to manage our cash and liquidity prudently. Thanks for listening, and I will now return the call to the operator for questions. Thanks.

If you'd like to ask a question at this time, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Hamir Patel with CIBC.

Hi. Good morning. One of your peers recently announced a large reduction of its pulp capacity in British Columbia. Just given your presence in the province, how much more pulp capacity do you think needs to come out of the region? And can you speak to how comfortable you are with the long-term capacity potential at Celgar?

Thank you, Hamir. Yes, obviously, this is something that actually news that we were expecting from some time. It is well known that the fiber supply in the province has been pretty tight and getting tighter and tighter as time goes by. So it comes as no surprise that that announcement came up yesterday. Now, one of the things that we've decided to do, and I think that it puts us in a very favorable position in the case of Selgar in B.C., is that we're taking full advantage of the strategic location of the mail very close to the U.S. border. That has proven for us extremely beneficial. Our cost of fiber have been coming down as we've started implementing that strategy. And that is basically allowing us to source chips from the U.S. at costs that are competitive as logistics have been arranged accordingly. And we're seeing more and more inflow from the U.S. into Celgar. we can easily think about sugar going as much as between 30% to 50% of fiber source from the U.S. So, again, that takes the pressure off the mill from this very complicated situation that B.C. is going through. Regardless, and I have to say that the Kootenays, that region in particular, has not been impacted as much as other regions in northern BC on reductions in access to fiber. So that also has helped CellGuard in a good way. We have a very good source for fiber in the mill, and we expect it to continue that way.

Great. Yeah, thanks for all that detail there, Juan Carlos. And the last question I had was on the lumber side. With respect to demand in Europe, Could you comment on what you're seeing there across the different end markets in terms of R&R, new res, industrial, and maybe where, if anything, stands out as inflecting on the R&R side?

Yeah, the European market has been very weak over the past, I would say, over the past year. The situation in the European economy in general, in Germany, which is probably the one that we focus ourselves a lot more, is still not in a recovery mode. It's still very dormant. The only thing that we have seen recently that has built a little bit of momentum, possible momentum, even in prices, has been the resurgence of the UK and Ireland markets. So we've been able to get back into that market after being out of it for almost a year. So Europe is still, I would say, very precarious and nothing that we expect any significant change, most likely for the next couple of quarters. We'll see if there's some improvement in economy indicators by the end of the year. And obviously, that would definitely push the construction industry in a better trajectory as it has been before, or at least in a recovery mode. So yeah, it's been very, very slow on air, incredibly slow. We have the advantage that since our mill is very competitive from a cost production point of view, we're able to serve the U.S. market very competitively. And obviously, we've taken advantage of that as much as we can. In the last year, we did exactly the same thing. Almost 50% of our sales went to the U.S. This year, it's been a bit lower than that, again, because U.K. and Ireland has shown good signs of recovery. But we always play that card. It gives us that confidence that if Europe is not giving us what we expect, then we can take advantage of the U.S. market.

Perfect. Yeah, that makes a lot of sense. That's all I had. I'll turn it over. Thanks, Juan Carlos. Thanks.

Our next question comes from the line of Sean Stewart with TD Cowen.

Thank you. Good morning. A couple of questions. The discretionary projects at Torgao and Spokane, can you give us a sense of the return parameters you're looking at for that type of capex? I suppose once markets normalize a little bit, How do you think about returns for those types of projects?

Absolutely, Sean. We have two important projects, as I was mentioning. The first one and both of them were envisioned when we acquired the mills. So if we talk first about Torgao, Torgao, as we acquired it, it has four saw lines, but it's not optimized in any way. It's an old mill, very big in size, with a lot of capacity, but it's totally underutilized. And it was focused its production on pallet production to a large extent. And what we are doing right now with this investment is we're freeing up capacity so that we can produce lumber in addition to what we're producing in free sales. And that additional capacity, that would put Torgao not only as a pallet mill, but both lumber and pallets, bringing a little bit down the volume of pallets, but really, really, really increasing the volume that we can get for lumber. So that's what we're planning for. The return on those projects is relatively short. We have those investments coming probably completed next year. So by the end of next year, we will already, which we believe that the number of prices will be better by the end of next year than they are today. So when we said that we're doing all this investment, doing the cyclical low part of the cycle, we're preparing ourselves to be ready whenever the markets rebound. The return of those projects, both lumber or what we're doing in Spokane, when we do it, it's usually less than three-year returns. So for us, those are high return projects in general terms. In the case of Spokane, it's the same. It's a similar situation. The mill, even though it's a brand-new mill when we acquired it, not because it's brand-new means that it was designed ideally or in an optimal way. So there's a few things that we need to do, particularly on sorting lines. Later down the road, we'll do some improvements on the press capacity, and those things will drive costs down significantly for us. Again, same as in Torgal, those are two- to three-year payback projects when fully implemented.

That's great detail. Thanks for that. Second question is on pulp markets. Curious on your assessment of current momentum, sustainability into the second half of the year, how much of the recent surge do you attribute, I suppose a lot of it is temporary supply constraints, but on the demand side, how much do you think is customer restocking versus real pull from paper demand improvement?

Absolutely, Sean. Yes, what you said is absolutely true. Supply constraint is a huge driver of the surge that we've seen in pulp prices. There's no doubt about it. And it's still increasing. We just heard the announcement yesterday of yet another closure, another 300,000 tons that goes out of the market. So the elements to keep the pressure upwards around prices is there, is sustained, no doubt. And we do believe that we will see further growth price improvements along the second half of the year. Now, when it comes to demand, it has been a lot better, but not as we would like, let's put it that way. So yes, European demand has improved. North American demand has improved. Chinese demand, not so much. We know that they're exporting quite a bit. So there's a balance on how much of that demand coming in from China goes elsewhere. But it is a fact that European, especially European, European was so low just, I would say, six months ago or nine months ago. Demand was incredibly low, and we've seen a very big resurgence of demand. It's still, I wouldn't say that it's strong enough as we'd like it, as we would prefer it to be, but it's obviously much, much healthier than it was before. So all in all, I think the prospects are positive. The logistic constraints that we see, the issues that we still see in the Middle East and the logistic constraints that that causes, now this potential issue of railway strikes in Canada, obviously those things just add noise and probably put more pressure on prices than anything else upwards. So again, we're bullish, probably cautiously bullish on the price increases that we may see in the coming months. I don't think there is any sign of software giving way within these current market conditions.

Thank you very much for that context. That's all I have.

As a reminder, if you'd like to ask a question at this time, please press star 1 1 on your touch-tone telephone. Our next question comes from the line of Harmon Dott with RBC Capital Markets.

Hi. This is Harmon on for Matt McKellar. I just had a quick question. You noted in the release that you'd begun work on certain large-scale mass timber projects as of Q2. Are you able to provide a bit more detail, more broadly, on the kind of pickup we should expect in manufactured product sales or EBITDA in the next couple of quarters?

Sure, Harman. To give you a sense of magnitude, we have two very large projects, and I wish I was at liberty to say the companies. I'm not allowed to say which companies they are, but We have two very large projects that are currently being produced at the mill. These projects will keep us busy for this quarter for sure. One of them is also going to be built up in the beginning of 2025. So we see the order book gaining good momentum, and therefore we see very positive results as a result of this. Now, one of those projects had a – A delay, a minor delay for them, but a minor delay for them means that instead of becoming a Q1 production project, it became a Q2 production project. And as we're ramping up, obviously when we have a major project that moves from one quarter to another, that creates a hole that we cannot fill as we would like. So that's why our results in Q1 for mass timber were very short, almost at break-even level. But in Q2, we expect mass timber to be much better in terms of profitability. Our sales for the year, we expect them to be almost twice as much as we had last year. So last year, our sales were around 60 million. We're estimating that for 2024, we should be around 100 to 120 million, give or take, with further sustained levels in 2025. One of the things that we're seeing in this market, which is not different from many things that we see in lumber spaces, with the interest rates being still at a very high level, what we're seeing is that, yes, there's more demand for more interest in projects to be built on mass timber. So there's a lot of tailwind on interest from developers, architects on mass timber. many more designs and many more quotations that we're putting out and projects that are being designed for mass timber than previously before. But what is happening is that there's a lot more that are being put on hold until the financing gets better for those developers. So what we expect is maybe in 2025, we won't see as much increase as we would otherwise have thought there would be until there's a start to see a reduction in interest. And then what we will see is all of this amount of projects that are being repressed, that are being put on hold, plus the ones that were coming up as new, that's going to come in a big wave. So we do expect a very, very strong growth of this business, whether it's in late 25 or 26, depending on how interest rates behave. and obviously we will take advantage of it. When we look at maturity from our business, we're looking at a business that should be north of 20% EBITDA when we're at maturity level and running at least two shifts on our facilities. So that's a forecast that we have, and we're very, very eager to keep on investing in these assets, make sure that all three of them, the Canadian one, And the two that we'll have in the U.S. are very cost competitive.

Gotcha. No, that's super helpful. And I think the rest of my questions were answered, so that was the main one. Thank you.

Okay, Harlan.

That concludes today's question and answer session. I'd like to turn the call back to Juan Carlos Bueno for closing remarks.

Thank you, Liz. And thanks to all of you for joining our call. Rich and I are available to talk more at any time, so don't hesitate to call either one of us. Otherwise, we look forward to speaking to you again on our next earnings call in August. Bye for now.

This concludes today's conference call. Thank you for participating. You may now disconnect.