MERC - Mercer International - Pulp Company

[FFHWatcher]

I have been looking at this for awhile and it is down 22% this year. My concerns are the debt ( D/E>2.0) , the FCF is low, and repayment of debt has been low. The price is attractive compared to the replacement of assets but very leveraged. If there is a commodities bust, it will not bode well for mercer.

 

Mercer certainly has its risks.  The share price is showing that moving from $14 to $6.  Not fun. 

 

I'm not sure how much you have researched Mercer but the real (default) risk is perhaps a little less than what it may initially seem to be.  Both debt and equity on the balance sheet are not plain vanilla. 

 

They have 3 mills.  All produce NBSK Pulp.  Rosenthal they bought and converted using something like $400M in capital including more than $100M in German Gov't grants.  Celgar, in Canada, they purchased in 2005.  It was already producing NBSK through an $850M CDN$ conversion and upgrade in the early 1990's.  Stendal is their 3rd mill.  They built it in Sept 2004 for just over $1B Euro including $275M Euro of Gov't Grants.  Stendal is very large and modern.  I believe between Rosenthal and Stendal, they are the only two NBSK producers in Germany and Germany is the largest European Country consumer of NBSK.  If you add up the capital of $400M in upgrades to Rosenthal + $1M Euro at Stendal and a Celgar which had $850M invested in it about 10-15 years before Mercer bought it, there is significant capital in the business.  Of course, that is mostly irrelevant based on what has occurred in the Pulp industry.  You can buy $500M pulp mills for $50M or $0...just take over the liabilities.  Therefore, equity in the business may not be that meaningful. 

 

In 2002, Mercer entered into an $828M Euro debt agreement and the German Federal and State Gov't guarantees upwards of 80% of the principal on that low interest rate (about 5.3%) loan that is due in Oct 2017.  Total due on Stendal loan as of Sept 2011 is down to $477M Euro (MERC has paid off $351M Euro in the last 7 years which is more than the market value of Mercer).  There are obviously provisions to pay down the provision regularly and basically all excess cash in Stendal goes to paying down loan.  Excess cash sure ain't leaving Stendal until the loan is paid off (I guess technically it could be but it ain't happening).  In 2008 and 2009 all hell broke out and they broke some covenants on that debt, so essentially Stendal is a stand alone entity, very little recourse to Mercer but obviously Mercer is heavily incentivized to see it succeed.  If it can mostly pay off the loan by 2017, then all that cash that has annually been paid into the loan could accrue to MERC shareholders.  A rough estimate/guess could say that Stendal is worth the value of MERC today, should that Stendal debt be paid off or even down to $100-200M Euro by 2017.  Summary : Stendal is cyclical, debt is mostly non-recourse to Mercer and it seems mostly to be a stand alone entity until debt is repaid or 2017.

 

Due to the size of the Stendal loan, among other things, the debt holders of the other $300M US$ of debt (Mercer really just has the Stendal Debt and the Restricted Group $300M US $ debt) requested that a 'restricted' group be set up.  The restricted group is Rosenthal and Celgar Mills.  It is important to understand all this restricted and non-restricted group stuff and the debt attached to each to understand the risks at Mercer.  Essentially, a close look has to be at the $300M debt in the restricted group.  Stendal is mainly non-recourse and it mostly operates as a stand alone entity that Mercer doesn't really invest the holding company's capital into but also doesn't receive any cash proceeds from.  It should in the future, but that is many years off.

 

Any financial flexibility and risk is more geared to the $300M US$ debt in the restricted group.  When you view MERC looking at the $300M debt, Rosenthal and Celgar, the restricted groups balance sheets, their energy revenues matching their interest expense, than the overall risk is lower than it first looks, in my opinion.

 

 

[eclecticvalue]

Thanks for reminding me about the German guarantee and writing a long post FFHWatcher. It seems default risk isn't likely to happen at the moment. Do you agree there is risk with China and if the whole crisis over there becomes worse, commodities such as NBSK will be lower? I think that is the main risk Mercer faces at the moment.

[FFHWatcher]

Thanks for reminding me about the German guarantee and writing a long post FFHWatcher. It seems default risk isn't likely to happen at the moment. Do you agree there is risk with China and if the whole crisis over there becomes worse, commodities such as NBSK will be lower? I think that is the main risk Mercer faces at the moment.

 

I agree with what you are saying.  It would seem to me that is a shorter term risk.  Guessing 1-12 month risk?  I could also point out that MERC has the majority of their operations in Germany and they report in Euros and 60% of their sales are in Europe, with the remainder in North America and China.  There are several positives but those are the significant risks and help explain the significant decline and low valuation multiple under most metrics.

[ValueSlant]

Thanks for reminding me about the German guarantee and writing a long post FFHWatcher. It seems default risk isn't likely to happen at the moment. Do you agree there is risk with China and if the whole crisis over there becomes worse, commodities such as NBSK will be lower? I think that is the main risk Mercer faces at the moment.

 

I agree with what you are saying.  It would seem to me that is a shorter term risk.  Guessing 1-12 month risk?  I could also point out that MERC has the majority of their operations in Germany and they report in Euros and 60% of their sales are in Europe, with the remainder in North America and China.  There are several positives but those are the significant risks and help explain the significant decline and low valuation multiple under most metrics.

 

Hard to know where pricing will go in short term, if had to guess I would think there will still be some more weakness in next few months. I did a post with some analysis of MERC and Canfor Pulp:

http://valueslant.com/2011/12/14/mercer-international-merc-opportunities-market-pulp/

 

ValueSlant

[Guest chai]

anyone is still following this?

Stock price has picked up this quarter..

[FFHWatcher]

anyone is still following this?

Stock price has picked up this quarter..

 

I still follow it a bit.  Haven't really looked at in over a year but started looking again a month or so ago.  Was the move up from $7-10 likely due to the better terms on the Stendal debt/covenants?  Mercer has certainly been better at preserving shareholder equity than Fortress Paper.  Just in checking, it looks like Canfor Pulp moved up similarly over the same time frame.  Has momentum for NBSK changed that much?

[Evolveus]

For several quarters now management has been saying on the conference calls that they have been expecting much higher nbsk prices moving forward as they felt it was selling near trough pricing. I think those price increases are finally materializing from a pretty low base.