Business/Thesis: MERC operates as a producer of pulp kraft, processing softwood and hardwood pulp. Notoriously cyclical business but a recent pull back in prices and the small cap nature leaves me interested. They operate three mills, two in Germany and one in Canada. They are a Seattle based company that reports all results in Euro's (just confusing enough to deter some investors). I believe this could be a valuable alternative energy play, especially now that German is trying to eliminate nuclear energy.
Stats: EV/EBITDA 4.21, P/S 0.36, P/B 1.23, P/LFCF 10.3. 1 director bought shares in the past month. P/E is a bubblicious 3.4. 5 year revenue growth has averaged 2.6%.
Cyclical thoughts: So 22% of global softwood pulp demand is directly related to Chinese consumption. W. Europe is 28%. Softwood is the more expensive of the two and as that may be, end producers have been trying to substitute hardwood in for softwood. This has disadvantages though and there is a "floor" for the amount of hardwood that can be introduced.
Demand/capacity ratios for the industry are 93%, 91%, 89% for 2010, 2009, and 2008 respectively. The big concern with this ratio is that worldwide it was estimated that 5.3million tons of NBSK were indefinitely closed 2006-2009, but 1.9 million tons were restarted from late 2009-2010. Should pulp prices remain high additional capacity can be added on. How quickly is an unknown. Its a classical cyclical nonetheless.
Why MERC? A lot of paper/pulp companies are trading at low valuations currently, to me indicating a peak in the cycle (analysts have begun to justify these and others because of their low P/E's...). I can't jump on pure pulping companies like UFS based simply on dirt cheap relative valuations and optimistic outlooks that Chinese consumption will remain strong in the face of inflation. MERC for me is going to be tied to the price of pulp on the market and for a while will continue to fluctuate as prices drop/rise.
To me though there is one big caveat that is relatively unknown, the energy producing facilities. All three mills of MERC produce their own energy from internally generated black liquor. All three mills create a surplus to the tune of 520,005 MWh in 2010. With the Celgar mill revamped expected production is >700,000 MWh. Last year energy production was Euro 44.2million, at 2008 (lowest demand for pulp in many years) sill sold 456,059 MWh to the grid. With the newly enhanced Celgar mill I calculate that energy productions could add total ~59M Euro of revenue. No other paper/pulp producer that I found was even as close to net energy positive as MERC.
The beauty of this to me is two fold. First and foremost it truly is renewable energy coming from trees. Second because its coupled to an actual profitable industry its going to be economically feasible. Two of the mills are located in Germany, with Germany recently banning nuclear the lost energy will have to be made up somehow. Typical carbon sources and renewable energy will fill the gap. A large portion of MERC's energy capex has been subsidized by the Canadian and German government and with the new legislative movement I see no reason why that will stop. Even if it does MERC in my eyes still represents the cheapest renewable energy source, which people will pay a slight premium for.
Debt covenants have severely restricted debt issuance on MERC, resulting in a company that needs to reduce Debt to EBITDA ratios from 13X to 4.5X in 2017. Obviously a lot can happen but with the energy production relatively stable and incredibly high margin (they would pay for it anyways) I think it warrants a good look to see if debt begins to decrease. Already it has dropped from 1039M in Dec 2010 to MRQ 975. Most of their employees are covered under union contracts, seem to have good relationships. Pension is underfunded by 24million.
Management has good levels of insider ownership at 6.2% SO, Chairman/CEO since 1992 owns 1.986M shares, took home 1,047,610 in compensation last year. At 11/share a lot of his wealth/motivation is intertwined with MERC shareholder returns, almost 20 years of salary.
Overview: I think this is a good company to play several macro trends but hesitate currently with high spot pulp prices. A multi-currency hedge is offered and upon a deleterious sell-off I would enter. With estimated energy revenues expected to generate Euro 59M soon a 10X valuation on 40% margins would give a MC of ~300M (10x EBIT seems to be a good starting common valuation for some energy producers). At this price you get the paper business for free. Even right now the electric business itself is worth ~200M (10X 40% margins on the Eu 44.2M generated last year). Currently with MC of 500M, you get the pulp business for 300M. No position.
7/12/2011: Talked it out and ran some new models. Its cheap just not extremely cheap. (Net income+D&A-CapEx)/EV gives numbers roughly in line with other pulp producers. A nasty correction below 8/share offers a compelling risk factor. Until then I'll hold off.
Update 7/13/2012
Mercer's shares have been creeping down. I spoke with their CFO at a conference in January and his words were "We're basically waiting for some of the high cost mills in Scandanavia to shut down and we should regain pricing power."
We are starting to see evidence that the high costs of pulping are indeed taking out some of the high cost producers, just not yet in in Scandanavia. This week a Tembec mill in Chetwynd, British Columbia announced they will be shutdown. This takes out 240,000 tonnes of capacity. This is 0.3% of all pulping capacity in the world based on 59.4M mt of capacity (page 6).
Tembec's EVP Chris black stated "At today's price levels, it is virtually impossible to maintain viable operations given the current cost structure of the Chetwynd mill." The pulp used at this mill is commonly used in printing and writing papers and tissue and towelling. Similar end uses as NBSK, Mercer's product.
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