Sunday, October 16, 2016

A current AIM International Fund holding: Mercer International (MERC) by Chengbin (Henry) Lu: “It will be worth the wait- knock on wood"

Mercer International (MERC, $8.22): “Hold on, it’s about the time to outperform”
By: Chengbin (Henry) Lu, AIM Student at Marquette University

Image result for Mercer International
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.


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.