Mercer International Inc.

Good morning and welcome to Mercer International's third 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, Josh. Good morning, everyone. Thanks for joining us today. I will begin by touching on the financial and operating highlights of the third 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 have joined 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'd 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 operating EBITDA totaled $50 million compared to Q2's EBITDA of $30 million. The improved quarter-over-quarter results were driven by fewer days of planned major maintenance downtime as we had 20 days in Q3 compared to 37 days in Q2. The benefit of fewer planned days of downtime in Q3 was partially offset by several unrelated and unplanned events that significantly reduced our pulp production in Q3, as well as unfavorable foreign exchange movements and weaker hardwood prices. Juan Carlos will have more to say about our unplanned downtime in a moment. Our pulp segment contributed quarterly EBITDA of $55 million, and our solid wood segment had quarterly EBITDA of negative $2 million. You can find additional segment disclosures in our Form 10Q, which can be found both on our website and the SEC's. The third quarter is typically a period of weaker seasonal demand, but softwood pulp markets remain steady, resulting in stable prices. Our Q3 softwood pulp sales realizations were $814 per ton, compared to $811 per ton in Q2. The North American NBSK list price averaged $1,762 per ton in the current quarter, an increase of $65 from Q2. The benefit of this increase was largely offset by lower price realizations in China, where the Q3 average NBSK net price was $771 per ton, down $40 from Q2. And in Europe, the NBSK list price averaged $1,573 per ton in the current quarter, a decrease of $29 per ton from Q2. Hardwood prices in China decreased due to new capacity coming online in 2024, which will require some time to be absorbed in the market. Our Q3 hardwood sales realizations were $632 per ton, a decrease of $69 from Q2. The average price gap in China between softwood and hardwood pulp increased this quarter to about $140 with the average Q3 net eucalyptus hardwood price at $635 per ton down $100 from Q2. The North American NBHK average Q3 list price was $1,467 per ton up $30 from Q2. Overall, the weaker hardwood pulp price outlook resulted in us recording a $4 million non-cash inventory impairment in Q3 against hardwood fiber inventories at the Peace River Mill. Today, pulp sales volumes in the third quarter when compared to the second quarter increased slightly to 449,000 tons, with roughly 85% of this total being softwood pulp. Total production volume in the third quarter was 416,000 tons, down slightly when compared to Q2, as a series of unrelated production upsets in the current quarter negatively impacted production by approximately 71,000 tons, offsetting the positive impact of fewer days of planned downtime in the current quarter. In Q3, we had a total of 20 days of planned annual maintenance downtime at our mills, compared to 37 days in Q2. In the current quarter, we estimate the planned downtime adversely impacted our EBITDA by approximately $18 million, a decrease from the Q2 impact of about $60 million. In Q3, we had no planned downtime, but as previously announced, we have incurred 12 days of unplanned downtime in Q4 at our Peace River Mill. For our solid wood segment, realized lumber prices decreased slightly as lower prices in the U.S. market were mostly offset by higher prices in Europe. Overall, in Q3, lumber markets remained weak. The random length U.S. benchmark for Western SPF No. 2 Embedder average price was $366 per thousand board feet in Q3 compared to $386 in Q2. Today, that benchmark price for Western SPF No. 2 and better is around $405 per thousand board feed, which represents about a 21% increase from the beginning of Q3. For Q4, we are expecting modestly higher lumber prices in the US and European markets due to stronger demand and reduced supply. Lumber production for Q3 was 122 million board feed, up 10% from Q2, due to fewer planned maintenance days in Q3. Lumber sales volumes were 109 million board feet in Q3, down 7% from Q2 due to the timing of sales. Our consolidated electricity sales volume totaled 205 gigawatt hours in the quarter, down about 14 gigawatt hours from Q2 due to planned maintenance work on the freeze-out turbine. Pricing in Q3 was flat compared to Q2 at $91 per megawatt hour. In Q3, both our pulp and solid wood segments' fiber costs were flat compared to Q2 as supply remained stable. Production for our solid wood segments' mass timber operations was strong in Q3 at 10,000 cubic meters as we completed two of the largest mass timber projects ever undertaken in the U.S. Foreign exchange negatively impacted our operating income in Q3 by about $10 million when compared to Q2, primarily caused by the impact of a weakening US dollar on our US dollar denominated receivables at our Canadian and German mills. We reported a consolidated net loss of $18 million for the third quarter, or 26 cents per share, compared to a net loss of $68 million, or $1.01 per share, in Q2. We consumed about $24 million of cash in Q3 compared to about $11 million in Q2, Our net working capital excluding non-cash adjustments was higher in Q3 by roughly $36 million, and we borrowed an additional $20 million on revolving credit facilities. At the end of Q3, our liquidity position totals $554 million, a $26 million decrease from Q2, and comprised $239 million of cash and about $350 million of undrawn revolvers. And you may have seen in our recent press release, but I wanted to highlight that this week we have reduced the principal balance of our senior note debt by $100 million. We did this by issuing $200 million of additional 2028 senior notes and using the proceeds and cash on hand to redeem our $300 million worth of 2026 senior notes. The new 2028 senior notes were issued at a price of 103% of their principal amount for a yield to worst of roughly 11.6%. In completing this transaction, we have also extended our maturities on $200 million of our senior notes by two years. Finally, our Board has approved a quarterly dividend of 7.5 cents per share for shareholders of record on December 18th, for which payments will be made on December 26, 2024. That ends my overview of the financial results, and I'll now turn the call over to Juan Carlos.

Juan Carlos Rodríguez- Thanks, Rich. In Q3, our operations resulted in a $20 million EBITDA improvement over Q2. However, we had higher expectations. Unplanned and unrelated downtime at a couple of our mills significantly reduced our operating results. We estimate that the negative EBITDA impact of this downtime was about $20 million. I will have more to say about this in a moment. I'm pleased to note that within our solid wood segment, our mass timber business had another strong quarter, generating revenue and margins consistent with what we accomplished in Q2. With regards to our Torgau operation, although our pallet business is still struggling under the weight of a weak European economy, we're beginning to realize certain synergies which are benefiting our Paul business. When we purchased Torgau, we estimated we would be able to achieve about $16 million annually. At the end of Q3, we had realized almost $5 million of synergies related to fiber optimization that are showing up in our pot most results, and we expect to achieve about $8 million in synergies by the end of the year. Once Torgao's lumber capacity is fully ramped up, we expect our synergies to increase, and we continue to believe that $16 million of annual synergies is achievable. As Rich highlighted, We recently completed the refinancing of our 2026 senior notes. I am pleased to have this behind us, and that we're able to reduce them by $100 million. However, we recognize there is more work to do on this front, and consequently, debt reduction will be an important focus of our capital allocation strategy going forward. In Q3, we invested roughly $27 million in our operations, As previously announced, our planned 2024 capital spending is expected to be between $95 and $120 million. You will recall that last quarter we restarted both our Torgau Lumber Expansion Project and the Spokane Sorting Line Project. Both of these projects will provide significant value added and were originally contemplated as part of our investment strategy for each of these mills. Looking ahead to 2025, we expect to target a CAPEX spend similar to the 2024 range. We will continue to prioritize maintenance of business, environmental, and safety-related CAPEX. Turning to the pulp markets, softwood continues to hold strong. We believe that demand for softwood will remain steady in the midterm, which, when combined with reduced supply, will create upward pricing pressure in most markets late Q4 or early Q1 in 2025. Conversely, hardwood pricing weakened in the quarter and appears to have landed at a floor price of around $550 in China. The permanent closure of NBSK mills in the last two years, the temporary curtailments happening today due to reduced fiber in certain regions, along with unplanned downtime, are all creating tightness in the NBSK supply-demand dynamics. Looking forward, we believe that the significant differences in the supply-demand fundamentals for both softwood and hardwood pulp will drive the price difference between these two grades to levels well beyond historical norms. Currently, the net price difference in China is about $230 a ton, while historically this price difference is closer to $100 per ton. We believe This larger than historical price difference will be with us well into 2025. As a reminder, soft sales volume represent roughly 85% of our annual pulp volumes. Rich noted that we lost approximately 71,000 tons of pulp production in Q3 due to unplanned downtime. This was a lost opportunity for us given where pulp prices are today. But I think it is important to note that this unplanned downtime was spread across our Peace River, Stendhal, and Selgar Mills and was all unrelated. At Stendhal, we lost about a week of production due to a supplier's error when installing new pulp cutter equipment. We have recently completed the root cause analysis for Peace River's digester issues, which concluded the unplanned downtime was related to the mechanical failure of a hydraulic motor that ultimately led to the digester being plugged. Our mills are largely in complicated facilities and maintenance downtime is a reality. But it was unfortunate that this all happened in the same quarter. As always, our teams are applying the learnings from these incidents as we move forward to avoid them from repeating themselves. We do not have any major maintenance planned in the fourth quarter. but we have already incurred in 12 days on-plan downtime in Q4 related to Peace River's digesters repairs. We have not finalized our full 2025 plan maintenance schedule, but we do expect Celga to take a 17-day shot in Q1 2025 that will include the final tie-ins for their wood rule project. As previously mentioned, Our solid wood segment results benefited from strong mass timber sales in Q3 as we completed two very large projects Rich was referring to earlier. The strong margin realized in Q3 highlights the potential of this business despite it operating on just one shift. And despite mass timber's good results, our overall solid wood segment was held back due to the impact of weak lumber and pallet prices. In Q3, we saw some small pockets of lumber price improvement in Europe, while the U.S. market weakened slightly. High interest rates globally continue to weigh on housing starts and construction in general. We expect Q4 lumber pricing to moderately improve in the U.S., as we believe the recently announced lumber production curtailments are starting to create some pricing tension. Similarly, we expect modest upward pricing pressure in the European market. Any meaningful long-term improvement in either the European or U.S. markets will be dependent on improved economic conditions, which we expect will be led by near-term interest rates reductions that will end up fueling a recovery in the construction industry in the latter part of 2025. 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 homeowners 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 Q3, 43% 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 $33 million, and 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 similar pace to what we have 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 that gives us competitive access to the entire North American market. Shipping pallets remain weak due to the overhang on the European economy and particularly in Germany. 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. Today, pallets are selling for about $11 a pallet on average. The historical average price for pallets is around $13 to $14, which would make Torgau highly profitable even without incremental lumber capacity. Heating pellet prices were up slightly in Q3 due to expected seasonality in this market. We expect demand and prices to increase modestly in Q4 as customers build winter stocks. As a reminder, we have restarted strategic and high-return CapEx projects at both Storgow and Spokane Mills. Torgao's project will increase the volume of dimensional lumber available for the U.S. market by about 240,000 cubic meters annually, with upgrades to the log-in feed system and the addition of more planing capacity. This was envisioned as part of our original investment thesis to increase the mill's value-added product mix and maximize potential synergies. I also wanted to remind you our Spokane project was originally envisioned as part of our investment strategy for this mill. This project is focused on the mill's wood-in feed 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 higher quality lamb stock. Ultimately, this will significantly reduce the mill's fiber costs. In Q3, our overall pulp fiber costs were flattened from Q2. In Germany, a steady supply of sawmill chips get fiber costs constant, and in Canada, Peace River's woodroom and our silverwood strategy also kept our fiber costs in check. Looking ahead, we expect our fiber costs to remain stable for our pulp business and with a slight increase in our solid wood business being due for. I am pleased with our new leading extraction pilot plant ramp-up, Our development and expected commercialization of this product is going according to plan, and I expect to share our vision for this product in the near future. We're excited about the future prospects of this product as a sustainable alternative to fossil fuel-based products such as adhesives and battery elements, among many others. We believe this product will be the foundation for our profitable business segment with strong growth potential. The fundamentals of this business align perfectly with our strategy, which involves expanding into green chemicals and products that are compatible with a circular economy or adding shareholder value. As the world becomes more demanding about 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 the softwood pulp markets remain strong. Our recent operational challenges were unrelated, and as a result of those operational challenges are behind us. We are expecting strong operating results from the pulp segment in Q4 and into 2025, which will leave us well-positioned to take advantage of steady pulp pricing. Regarding our solid wood segment, we expect weak economic conditions to continue to keep pressure on demand for pallets in Europe. However, we are seeing signs that cause us to be cautiously optimistic about lumber demand and pricing in Q4 and into 2025. Finally, we will remain focused on our cost-saving initiatives and will continue to manage their cash and liquidity prudently while looking for debt reduction opportunities. Thanks for listening, and I will now turn the call back to the operator for questions. Thank you.