Tembec had a good day today. Mercer needs to catch up now. I like Mercer even more then Tembec. They are extremely leveraged to the price of pulp and also to the earnings multiple analysts are willing to give to the industry. They have a lot of debt but it was accumulated in building some of the newest and lowest cost mills in the world. A lot of the debt is owned to the German gov't in a long term loan. Below I copied some of my notes on the company:
Weighted average number of common shares outstanding:
Performance rights 425,668
Convertible notes 20,197,563
Whats the Book Value?
* Total equity is $131M
* There is $31M of non-controlling interest, so the net equity on the books is $100M
* From the Capital Structure PP: Mercer equity does not include EUR 406 million in government grants; these grants have been credited against fixed assets and amortize over the fixed assets depreciation term
* From the Capital Structure PP: Adding back the grants to equity would reflect the value of the money contributed from the government to Mercer. The unamortized amount is, as at June 30/2010, EUR 295 million
* from their Ideas Presentation:
o Shareholder’s Equity = (1) €131.2
o Add: Government Grants Received (2) €284.0
o “Adjusted” Book Value = €415.2
o Adjusted Book Value Per Share (US$) $13.96 (based on 36M shares)
Return on Capital and Earnings Yield The Second Quarter
Return on Capital and earnings yield are two metrics that I learned from Joel Greenblatt books. Mercer is strong in both regards:
* The enterprise value of Mercer is E1000M at a $5 share price. 1.3E/USD exchange and E860 of debt (EV is Market Cap + debt)
* Using Greenblatt definition of tangible capital employed (Net Working Capital + Net Fixed Assets) I get E983M
* EBIT in Q2 was E48M and and EBITDA was E62M
* So Greenblatt formula shows Return on Capital of E196/E983 = 20.3%
* Earnings Yield is E196/E1000 = 20%
* the thing is that because of the massive debts associated with Stendahl, most of that EV is debt. So shareholders are highly leveraged to changes in the earnings yield, or in other words changes in pulp prices or the multiple given for them
Return on Assets and EV/EBITDA
This is the more traditional valuation metric used by most brokerages.
* RBC has ROA at 6.3% (ROA is just net income / total assets) * RBC also says they should trade at 5.4x EV/EBITDA - right now they are trading at about 4x EV/EBIT - 5.4x at the current EBITDA level of E62M would mean a share price of $17/share (1.3 USD/E exchange) - so there is your upside if pulp prices stay strong
* They are so sensitive to the multiple they get. At 6x EV/EBITDA you get $22 share price (1.3USD/E)
* They had E34cents basic and E23cents diluted earnings
* Their costs were much higher then in Q. Operating costs were $19M more then Q1 and $28M more then the first half average of 2009
* costs were higher because of maintenance at Celgar (maintenance costs go right on the income statement, are not expensed) and because of higher wood chip costs in Germany
* They also took some hits due to non-cash items: The net income includes EUR13.8 million of expenses related to our mark-to-market valuations on our fixed interest rate swap and U.S. dollar-denominated debt. Were it not for these non-cash items, EPS would have been EUR.72 per share - CC
What to expect from Q3
* Shutdowns: They are shutting down Rosenthal for 12 days and the power generator for 50 days. They said on the Q2 CC that costs would be less then the Q2 costs
* wood costs: are expected to be close to the costs in Q2 so this is probably negligable
* Euro - presumably there will be some impact of the higher Euro and CDN dollar in Q3 versus Q2 and it will be negative but it also increases their USD earnings (since they trade in USD) so I think this is a wash
* Pulp Prices: its hard to estimate this. The list prices didn't really come down much in Q3 but there were discounts in August so I think prices may be down $50/t or so. On the other hand there is a lag in the revenue Mercer books, and so they will be booking revenue for some of June as well
* Other items: They took a E9.3 hit on foreign exchange and a E4.4 hit on variable to fixed interest rate swaps - I think that with the move up in the euro could reverse the former. I'm not really sure how the interest rate swap will move going forward - if these are reduced to 0 in Q3 that is a gain of E0.38/share
How much does it cost for Mercer to produce Pulp?
* Operating costs were $168M in Q2 and $308M in the first half
* They sold 365kt in Q1 and 698Kt in the first half
* So costs were $460/t in Q2 and $440/t in the first half
* Costs in the long term were (assuming $1.3E/USD exchange):
o $444/t in 2009
o $500/t in 2008
o $500/t in 2007
How much is Mercer getting for their Pulp?
* NBSK price in Europe in Q2 was E752/t
* They realized E618/t
* That’s a difference of E134
* Now they said that no one gets list but even at a 14% discount they are lower by E30/t of price. That works out to sales of E11M that they lost out on due to the difference, or $14MUSD or almost $0.50/share
* They said that the difference between prices and sales was: Sales realizations after discounts. Incorporates the effect of pulp price variations occurring between the order and shipment dates.
* So presumably some of this difference is due to the lag in pricing. Q3 should see catch up here.
What about the Convertible
* they have 20.2M convertible notes that had a value of $48M as of Mar-31-10
* From the q1 10q: As at March 31, 2010, the Subordinated Convertible Notes due October 2010 had approximately $2.3 million of principal outstanding. The Subordinated Convertible Notes due October 2010, bear interest at 8.5% accrued and payable semi-annually, are convertible at any time by the holder into common shares of the Company at $7.75 per share and are unsecured.
* From the q1 10q: The Subordinated Convertible Notes due January 2012 bear interest at 8.5%, accrued and payable semi-annually, are convertible at anytime by the holder into common shares of the Company at $3.30 per share and are unsecured.
* I think what happened is they exchanged a bunch of the $7.75 notes for $3.30 notes, which really brought up the share count (from 9M to 20M)
* Its a $36M loan at 7% due 2017
* The loan is in the non-restricted group balance sheet (Stendahl)
* I’m not really sure who the loan is to and if you should classify it as equity or not.
* The company includes it in their equity in their presentations of book value
Current Market (from Q2 Conference Call)
* sounds like there is some excess inventory on the paper side in some grades in China
* they think that the pulp inventories in China are likely quite low, possibly extremely low
* there are a number of new paper machines that are being built in China. These machines need to run and they need nbsk to run; it will be too costly not to run them
* they mentioned that China is still looking to shut 4.5Mt of capacity, but no one knows when that is going to happen
* they expect that Q3 is not going to be as good as Q2, point to the list price reductions in China and in NA
* the $50/t decrease by Canadian producers hasn't generated volume
* some of the larger buyers of pulp are seeing pricing pressure on their products and that is why they aren't buying
* they think that the gap between nbsk and nbhk is sustainable - the end users of the hardwood and softwood are different
* they have reiterated a few times that the price decrease in July has not led to much ordering. They are building inventory right now and have 'concerns' about their order book.
* in the longer term though they think that the closures of mills from when the nbsk market collapsed is going to be felt more and more