By:
Chengbin (Henry) Lu, AIM Student at Marquette University
Disclosure:
The AIM Equity Fund currently holds this position. This article was written by
myself, and it expresses my own opinions. I am not receiving compensation for
it and I have no business relationship with any company whose stock is
mentioned in this article.
Summary
• Mercer International Inc. (NYSE:MERC) is one of the largest northern
bleached softwood Kraft pulp (NBSK) producer in the world. The company has
three advanced pulp mills with a total annual capacity of 1.54 million tonnes
and 305 MW.
• In Q2 2016, Mercer
achieved EBITDA of $34.7 million compared to $45.3 million in Q1 2016, which
was mainly caused by its longer-than-expected maintenance shutdown at one of
its mills. This unforeseeable event created the $21 million drag on EBITDA in
Q2.
• Higher capital expenditures
was spent on two high-return projects. One project is aimed on reducing variable
cost. The other is focused on increasing production capacity.
• The board approved an
$0.115 dividend for shareholders of record on September 26 and said that the
dividend is expected to be sustainable. Currently the dividend yield is 5.43%.
Key
points:
According to MERC’s
management, the main reason why the company underperformed in the second
quarter was its ambitious maintenance shut at one of its mills, which lowered
the total NBSK pulp production. However, MERC expects that the productivity of
this mill will improve significantly in the third quarter and gradually climb up
to the peak achieved in 2010.
The main driver, which is
the increasing demand for NBSK pulp from emerging markets, still exists. Growth
in global NBSK deliveries remained steady at 3.5% in 1H2016 and China, in
particular, remained solid at 6.7% growth. With strong demand for tissue and
paper packaging both in Europe and China and stable outlook for NBSK pulp
supply, the sales price is expected to increase in the future.
As being mentioned
earlier, Capital expenditure grew almost $14MM during the second quarter. The
majority of it was spent on its railway log deliver system project and capacity
expansion project. This new log deliver system will allow MERC to reach further
East in Europe to secure cheaper fiber and to carry 65% more capacity each time
than older deliver system.
What
has the stock done lately?
MERC
stock currently sits at $8.22 dollars a share. Largely affected by the
unexpected maintenance and usually weak demand during the second quarter,
company’s stock price has been underperforming compared to the benchmark for
the last three months and trading in the range between $7.89 and $8.77. The
company recently announced the filing of a universal shelf registration of $650MM.
Past
Year Performance: Over the past twelve months, the stock
price has decreased 23%. However, Since February 2016, the stock has grown over
36% mainly caused by relatively strong earnings despite the cyclicality of in
the NBSK pulp market. The demand for NBSK pulp overall has grown 3.5% in last twelve
months. Overall all three mills have performed very well in terms of pulp
production except the unexpected maintenance shutdown happened on one of them,
which caused the sluggish earnings in 2Q16.
Source:
FactSet
My
Takeaway
Even though company’s
stock price has underperformed compared to the benchmark over the past year, I
remain confident on MERC’s ability to generate strong free cash flow in the
future because of the growing demand of NBSK pulp and continuous implementation
of the cost-cutting projects. Additionally, the management mentioned in the
2Q16 conference call that it will maintain the dividend payout in the future,
which I believe is a positive signal showing its confidence about future
earnings. I recommend the fund continue to hold Mercer International while
collecting the dividend and waiting for my investment thesis to be realized.
