Mercer International Inc.

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

Good morning, everyone. Thanks for joining us today. I will begin by touching on the financial and operating highlights of the second quarter before turning the call over to Juan Carlos to provide further color into the markets, our operations, and our strategic initiatives. Also, for those of you that have joined the call today 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 be making 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 totaled $30 million, compared to Q1's EBITDA of $64 million. The lower results were driven by 37 days of planned major maintenance downtime split between two mills compared to no downtime in Q1. We estimate the planned downtime adversely impacted our EBITDA by approximately $60 million. After adjusting for the planned maintenance downtime impact, the improved operating results were primarily driven by higher pulp sales realizations. Our pulp segment contributed quarterly EBITDA of $32 million and our solid wood segment contributed quarterly EBITDA of $3 million. You can find additional segment disclosures in our Form 10-Q, which can be found on our website and the SECs. Strong demand for pulp in Q2, combined with softwood supply interruptions in Finland, pushed prices higher than Q1 in all our major markets. In China, the Q2 average MBSK net price was $811 per ton, up $66 from Q1. European MBSK list prices averaged $1,602 per ton in the current quarter, an increase of $202 from Q1. And the North American MBSK list price averaged $1,697 per ton in the current quarter, an increase of $257 from Q1. The North American NBHK average Q2 list price was $1,437 per ton. up $214 from Q1. The price gap between softwood and hardwood pulp narrowed slightly this quarter in China, with the average Q2 net eucalyptus hardwood price at $735 per ton, up $73 from Q1. Total pulp sales volumes in the second quarter decreased by 132,000 tons to 433,000 tons, driven by lower production from planned maintenance downtime and the disposition of our equity interest in the Caribou Mill at the end of Q1. All our mills ran well this quarter. In Q2, we had a total of 44 days of downtime at our mills, which included the 37 days for planned annual maintenance and seven days due to slower than expected startups. In Q1, we had no planned maintenance downtime. After adjusting for the planned maintenance and impact of the disposition of our equity interest in the Caribou Mill at the end of Q1, pulp production was flat from the first quarter. For our solid wood segment, lumber pricing was mostly flat as modestly higher prices in Europe were offset by lower prices in the U.S. market. Overall, in Q2, lumber markets remained weak. The Random Links U.S. benchmark for Western SPF No. 2 and better average price was $386 per thousand board feet in Q2 compared to $447 in Q1. Today, that average benchmark price for Western SPF and better is around $355 per thousand board feet, about 16% decrease from the beginning of Q2. For Q3, we are expecting generally flat lumber prices in the U.S. and European markets as demand is expected to remain weak. In the second quarter, we recognized a non-cash goodwill impairment of $34 million, or $0.51 per share, related to the Torgal facility as a result of ongoing weakness in the European lumber, pallet, and biofuel markets. Juan Cardos will have more to say on this in a moment. Lumber production for Q2 was 111 million board feet, down 12% due to planned maintenance. Lumber sales volumes were 117 million board feet in Q2, down 4% reflecting the lower production. Our consolidated electricity sales volume totaled 219 gigawatt hours in the quarter, down about 41 gigawatt hours from Q1, reflecting the lower production at our mills. Pricing in Q2 was essentially flat at about $91 per megawatt hour from $94 in Q1. In Q2, our pulp and solid wood segments fiber costs were both flat compared to Q1 as supply remained stable. Production for our solid wood segments mass timber operations was strong in Q2 at 11,000 cubic meters, an increase of about 54% from Q1 due to the timing of mass timber projects. We reported a consolidated net loss of $68 million for the second quarter, or $1.01 per share, compared to a net loss of $17 million, or $0.25 per share, in Q1. We consumed about $11 million of cash in Q2 compared to about $40 million in Q1. Our net working capital was lowered in Q2 by roughly $49 million, which provided the cash to repay $45 million of borrowings on our revolving credit facilities. As our operating cash flow improves, we will continue to target opportunistic debt reduction. At the end of Q2, our liquidity position totaled $581 million, a modest improvement from Q1 and comprised $263 million of cash and about $317 million of undrawn revolvers. Finally, our board has approved a quarterly dividend of 7.5 cents per share for shareholders of record on September 25th for which payment will be made on October 3rd, 2024. That ends my overview of the financial results. I'll now turn the call over to Juan Carlos.

Thanks, Rich. Our Q2 operating results were positively impacted by significantly improved pulp pricing, our mass timber business, and lower energy costs. These positive effects were more than offset by plant maintenance downtime, which negatively impacted our Q2 EBITDA when compared to Q1 by about $60 million. Overall, all our mills ran well this quarter, but the planned downtime and related slow startups negatively impacted our sales volume relative to Q1's record pulp sales volumes. Our lower Q2 sales volumes also reflect the divestment of the Caribou mill at the end of Q1. I am pleased to note also that within our solid wood segment, our mass timber business was able to execute on some tight deadlines this quarter, which resulted in positive operating results. I will have more to say about this in a moment. As Rich noted, this quarter we rode off the goodwill we recorded with the acquisition of Torgau. Regardless of the technical rules around accounting for goodwill, the fact is the pallet and lumber businesses in Europe have been weaker for longer than we anticipated. And this is due to a number of factors, including the high interest rate environment in Europe that has had a dramatic negative impact on the construction business with a direct impact on lumber prices. And in addition, the unprecedented slowdown of the German economy has reduced the commercialization of goods, which is critical for the pallet business. But despite this write down, we continue to expect to realize significant shareholder value from this investment. including the synergies we identified as part of our acquisition strategy. We're currently ahead of schedule on our capital investment at Torgao that will expand the mill's dimensional lumber capacity and expect to begin to see the benefit of this investment in mid-2025. In Q2, we invested roughly $20 million in our operations. As previously announced, our stronger operating results outlook has allowed us to adjust our planned 2024 capital spending to be between $100 and $120 million. You will recall that last quarter we restarted both our Torgao 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 remain optimistic about our cash generation forecast for the remainder of 2024 and will be prioritizing debt reduction as we move forward. Overall, pulp markets improved significantly in the quarter, with both the European and North American markets showing the most improvement. We were seeing improved demand from European paper and tissue producers. This demand was primarily the result of merchant destocking and logistical challenges around Chinese imports. To a lesser extent, we were also seeing demand increases in North America. The permanent closure of NBSK mills in the last two years The impact of the Finnish transport strike and the significant unplanned downtime at one of the Finland's largest mills created softwood supply challenges, further tightening the supply-demand dynamics. Looking forward, we expect modest downward pulp price pressure into the third quarter due to slower seasonal paper demand. However, we expect some positive pricing pressure late in Q3 and through Q4, due to both ongoing global softwood supply challenges and increased seasonal paper demand. We're closely monitoring the Canadian Railway Union labor issues and have taken steps to mitigate the potential impact it may have. In Q2, we produced 422,000 tons of pulp compared to 539,000 tons in Q1. This reduction was due to the impact of the 44 days of major maintenance that we had in Q2, plus the divestment of Caribou Mill at the end of Q1. Our remaining major maintenance downtime in 2024 is scheduled as follows. In Q3, Rosenthal will take a 14-day maintenance shut, and Selga will take a four-day mini shut, which will amount to about 20,000 tons production loss in total. and we won't have any maintenance plans shut down in Q4. As a reminder, Celga will not have major maintenance shut in 2024 as the mill has moved to an 18-month maintenance schedule. Our solid wood segment results benefited from improved mass timber sales in Q2, but was not enough to compensate for the impact of lower lumber prices on average, with some small pockets of improvement in Europe while the U.S. market weakened. High interest rates globally continue to weigh on housing starts and construction in general. We expect Q3 lumber prices to stay essentially flat. There may be some short-term lumber pricing upside due to recently announced lumber production curtailments, the current forest fire situation in Western Canada, and the potential for a prolonged Canadian railway strike. Any meaningful long-term improvement would be dependent on improved economic conditions. That said, we continue to believe that low lumber inventories, the large number of sawmill curtailments, relatively low housing stock, potential wood shortages created by 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 midterm. In Q2, 39% of our lumber sales volume was sold in the U.S., as we continue to optimize our mix of products and target markets to current conditions. Today, our mass timber order file sits at about $55 million. We continue to receive many inbound project inquiries, and our finding developers are taking their projects to the point of being ready to execute once the interest rate environment improves. Economic stability will meaningfully improve the short-term demand for mass timber. In addition, we remain confident that the environmental, economic, and aesthetic benefits of mass timber will allow this building product to grow in popularity at a pace similar to that what we've seen in Europe. We are well positioned to take advantage of that market growth, as we have roughly 35% of North American mass timber production capacity, a broad range of product offerings, and a large geographic footprint, giving us competitive access to the entire North American market. On the other hand, Shipping pallets remain weak due to the overhang of the European economy, particularly in Germany. However, due to our efforts to improve our product mix, we saw a slight increase in average pallet prices in Q2. Once the economy begins to show signs of recovery, we expect pallet prices to return to normal levels, allowing this asset to deliver significant shareholder value. Heating pallets. We're down slightly in Q2 due to expected seasonality in this market, but we expect demand and prices to increase in Q3 as customers build their winter stocks. As I previously noted, we have restarted strategic and high return CAPEX projects at both our Torgau and Spokane mills. I've already spoken about Torgau's project, and I wanted to remind you our Spokane project was also originally envisioned as part of our investment strategy for this mill. This project is focused on the mill's wood infeed and sorting processes. Once this project is complete 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 Q2, our overall pulp fiber costs were flat from Q1. In Germany, a steady supply of sawmill chips resulted in modest cost decreases and in Canada, a ramp up of Peace River's wood room and our Selga wood room strategy, wood strategy also kept our fiber costs in check. Looking ahead, we expect our fiber costs to remain stable for both our pulp and solid wood businesses in Q3. I am pleased with our new lignin extraction plant ramp up and the partnerships we have entered into. to support the future commercialization of this product. I expect to share our vision for this product in the near future. 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, among many others. This aligns perfectly with our strategy, which involves expanding into green chemicals and products that are compatible with a circular carbon economy while adding shareholder value. 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 mast timber businesses. In closing, I am pleased that our pulp markets have improved and that we have the majority of our major maintenance behind us. We're expecting strong operating results from this segment in the second half of 2024. Regarding our solid wood segment, we expect weak economic conditions to continue to keep pressure on demand for construction products and pallets. Finally, we will remain focused on our cost-saving initiatives and will continue to prioritize debt reduction as we manage our cash and liquidity prudently. Thanks for listening, and I will now turn the call back to the operator for questions. Thank you.

Thank you. If you'd like to ask a question, please press star 1-1. If your question hasn't answered and you'd like to remove yourself from the queue, please press star 11 again. Our first question comes from Hamir Patel with CIBC. Your line is open.

Hi. Good morning. One, Carlos, once the projects at TORGAU are completed, which I think are slated for mid-2025, how do you see the percent of fewer lumber shipments that you sell to the U.S. changing?

Hello, Hamir. Yes, what we're expecting with these investments is that once everything is concluded, we'll have about a 25% increase in our timber capacity. So we will be able to work with at least 200,000 cubic meters more of wood into our mill. When we look at our total plain lumber capacity, we're thinking that we may be able to add about 240,000 cubic meters of planning capacity. So obviously a part of that will be destined to the U.S. How much goes to the U.S. will be determined as we normally do based on how we see prices developing in Europe versus the U.S. If you think for a minute, I think it was last quarter or the quarter before that, We were talking about how much was going to the U.S. I think we were up to 55% of our business going to the U.S. a few quarters back. This quarter we closed at 39%, and this is because we saw some important improvements in the U.K. and Ireland market, and therefore we decided to divert a little bit more of lumber to that space. So we will keep on having that fluctuation. I would say on average anywhere between 40% to up to 60% as a maximum would be the amount that would flow into the U.S. at any given point in time.

Okay, great. Thanks, Roncos. That's helpful. And I wanted to ask on the pulp side, there's been some reports recently in RISI that Susanna was piloting a kind of new hybrid grade, which I think they call the Eucastrong, to compete with Softwood. How do you see the threat to NBSK from some of the innovations that are playing out on the hardwood side?

As always, those faults will end up finding some space. The way that we see it is as we work through our customers and our teams, not only our sales team, but our market development teams, the technical guys that are working close with customers to make sure that their furnaces are properly set up for the products that they end up producing. That bond, we keep on strengthening further and further, so substituting that with an unknown grade, I know it's going to be quite challenging. So we have comfort in making sure that with those customers that we've had longstanding relationship with our softwood pulp, that those will remain. And therefore, we don't see this as a very significant threat. I wouldn't be surprised if a product like this ends up flowing more into a less demanding market, whether it's China or others, where quality is a bit more flexible. But in the case of some of the markets that we play or some of the customers that we play, I think it's going to be a bit more challenging.

Okay. Fair enough. That's all I had. I'll turn it over. Thank you.

Thank you. Our next question comes from Brandon Hull with CIFC Asset Management. Your line is open.

Hi, good morning. Thanks for taking my question. Just a real quick question about the pulp market as you're seeing it right now. Could you give a little color on what you're seeing in Asia? I guess some of the trade publications were saying that prices in Asia were moving down pretty substantially last week. I just want to see if you're seeing that and what the sort of play on interplay between what you see there and what happens in Europe?

Absolutely, Brandon. Obviously, we need to make two distinctions. The first one, what's happening on hardwood versus what's happening on softwood. Hardwood, it's undeniable that there's been an important correction on hardwood, probably about $100. And this is on the back of Cerrado and from Susano coming up. That was 2.6 million tons. And also the Liangshen product in China, project in China, that was 1.7 million tons. So all that pulp coming to market, obviously that puts pressure. It makes sense that in a market that is oversupplied, you would start seeing some corrections very quickly. And that is what has happened. However, The situation in softwood is different. If anything, softwood is still under a very tightness situation when it comes to supply, so very, very different from where we see hardwood. Even when we look at the demand to capacity ratio, the way it's evolving, we're seeing that softwood is going to 93% next year. and hardwood is going to go down to about 86%. Again, the pressure on hardwood will remain while softwood will be in a very different situation. That would mean that the spread between the two will expand. Obviously, there's going to be some pressure on substitution and whatnot, but I think the fundamentals for softwood being so tight on supply are going to be still very relevant. Even if you think about, I think it was recently this week, there was another announcement from another mill in Finland that they're already thinking about laying people off and stopping for, I think it's three months, what I understood it was. And this is a big mill. If they stop for three months, it's almost taking away another 200,000 tons of pulp from the market in any given year, if it's only three months. Again, it just exacerbates the fact that supply on softwood continues to be tight and will be even tighter as we progress. What that will translate into is that even if hardwood drops by 100 like it did, the drop in softwood would be mitigated pretty much and very limited. So far, the softwood prices, they have come down a bit. I would say probably less than $50, and that's more or less where we think they will most likely remain. Our belief is that as the year progresses and we get past the summer season, which obviously comes with low demand, both in Europe and in China, demands will pick up again and prices, and we can recover a little bit of the lost ground in this Q3. Again, we don't expect that ground to be very significant in Q3. I hope that helps, Brandon.

That's good color. Thank you very much. In Germany, and obviously you talked about the economic struggles there, are you seeing any signs of improvement there yet, or is it sort of bouncing along this low level?

It's still very timid. Obviously, we see that at least the European authorities' interests are starting to come down, which is a good sign. However, Germany as a country in itself is probably lagging a little bit behind the rest of Europe, which is contrary to what everybody's used to when Germany is the one that's leading the pace. In this case, it's different. It is lagging behind a bit, and that is probably the reason why We believe that the improvement or the recovery, especially in the construction sector, is gonna take a bit longer than what you would expect. And that's what keeps us a bit more conservative on what we think we can expect for either lumber prices, or in the case of the German economy itself, what we can expect for the pallet prices in the short term. We're hoping for more of a half, second half 2025 commencement of some signs of improvement. Because even if interest rates are cut now, that doesn't mean that immediately you'll have an impact and lumber prices will go immediately up. We believe that there's a lag between one action and another. So that's a little bit of the timing that we have in our planning.

Okay. Thanks very much for taking the questions.

Thank you. As a reminder, if you'd like to ask a question, please press star 1-1. Our next question comes from Kasia Kopitek with TD Cowan. Your line is open.

Hi. Good morning, everyone. It's Kasia on the line. You articulated a focus on deleveraging over the midterm. Just curious about your updated thoughts on potential asset divestitures to expedite that.

Hi, Kasia. The only thing that we've got on the books right now for sale is Santhenol, and that process is ongoing, and we don't expect any further write-down on that.

Okay, gotcha. Rich, can you talk about your order file and how that varies throughout the cycle, just trying to get a sense if there's going to be any order file timing lags reflected in your Q3 average price realizations?

Are you referring to mass timber?

No, sorry, pulp.

Yeah, so I guess maybe expand on what you mean by order file a little bit because we sell primarily spot in Asia, and in Europe, we basically sell the mills out every month. Yeah, we've got pretty low inventories across the board.

gotcha okay so we sell it every month but if you know if you're selling to a customer it wouldn't ship for let's say two weeks or three three weeks at this point what does that like look like okay for delivery times again it depends in europe or it's a number of weeks like one to two weeks generally work depends where it's going but in asia yeah it would take uh 30 to 60 days to deliver okay okay got it yeah i'm just trying to get a sense you know prices are rolling off here but maybe Maybe, you know, not all of that's going to be reflected in Q3. Maybe some of that will bleed into Q4, just trying to get a sense of the timing. But that's the color thing.

Yeah, okay, great.

Sorry, go ahead. You were about to say something.

Yeah, I was just going to say, if you're trying to use like an average, like a 45-day average, it'd probably be for your modeling purposes.

Okay, yeah, I got it. That's a good rule of thumb. Thanks. So good pickup on the top line for the mass timber business. Is that EBITDA positive at this point?

Yes, it is. It was EBITDA positive, I think, since Q4 of last year. It was the first time that it was EBITDA positive. It was very strong. It was strong this quarter. So we're looking forward to the growth of the business in 2024. We're expecting it to be probably twice the amount of sales that we had in 2023. It should be around $110 million by the end of the year. And Q2 was particularly strong. There was some projects delayed from Q1 that ended up being kind of all compounded into Q2 that made us running against the clock in Q2. We delivered all the projects on time and no complaints whatsoever. Quality on spec, everything very well produced and delivered. And that allowed us to run our mills more efficiently on one shift only. at this point in time. So that's why Q2 was, I would say, more stronger, or stronger than what we had planned for, as they were picking up a little bit of the slack from Q1. And this is on the back of customers delaying some of their projects, and therefore we have to adjust with whatever the customer planning schedule is, and that's the situation that followed in Q2. In Q3 and Q4, We don't have any more or very little of the big, big, large-scale projects that we had at the beginning of the year. So that's a little bit of a change in dynamic. It's going to be smaller projects that we attend to during the second half of the year.

Thanks for that. That's helpful. Carlos, can you remind me, what kind of EBITDA margins are you looking at for those sales?

We talk about EBITDA margins in the long term. more than specifically what we do right now. And we aim for 20%, between 10% and 20%. In the long run, it's going to be around 20% or more. That's what we expect of mass timber.

Okay, but right now you're probably just low single digits, I imagine, something in that range?

Yeah.

Okay, gotcha. That's all I had. Thanks very much, everyone.

Thank you. And the important thing, Kasia, just to expand on that, keep in mind that right now the margins that we're seeing is running with one shift. And not being able, only in Q2, we had those shifts practically full in our facilities. Going forward, as we expand this business, obviously the margins can grow as we can put two shifts or even three shifts into those facilities. So that is the key thing here is for us to grow this business in a way that we can add more shifts and take advantage of the capacity that we have installed and therefore have a better return on those fixed costs.

Thank you. I'm showing no further questions at this time. I'd like to turn the call over to Juan Carlos Bueno for closing remarks.

Okay, thank you, Michelle. 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 one of us. Otherwise, we look forward to speaking to you again on our next earning call in November. Bye for now.

This concludes the program. You may now disconnect. Everyone, have a great day.