MERC - Mercer International: Green Shoots May Finally Be Appearing

2023-12-06 04:13:46 ET

Summary

• Mercer International's third-quarter earnings report has led to a rise in share prices, with net profit improving and production costs decreasing.
• The CEO believes that pulp prices have bottomed out and will begin to rise, although economic uncertainty in China and Europe may affect demand.
• Mercer's liquidity has received a boost through a private offering, which buys the company time during the current downcycle.

Intro

We wrote about Mercer International Inc. ( MERC ) back in September of this year when we stated that low pulp prices would most likely keep shares of the pulp manufacturer depressed for some time. We downgraded our rating on the stock from a 'Buy' to a 'Hold' However, the one disclaimer we had in that commentary was the potential of an emerging bullish trend if indeed the $9 to $9.50 level (approx) could eventually be taken out to the upside. Well, Mercer's third-quarter earnings report managed to do just that as we see in the short-term technical chart below.

Shares traded above $10 a share on November 21st last and now seem to be testing underside support (what was formerly overhead resistance) in recent sessions. Apart from the significant GAAP earnings beat in the quarter, plenty of encouraging trends resulted in a nice 'pop' in the share price. Net profit improved from -$98.3 million in Q2 to -$26 million in Q3 as production costs moved significantly lower aided by minor price increases in selective markets.

Pulp Prices Bottoming Out

The key issue though is concerning where pricing is headed and here the market seems to be pricing in better times for Mercer going forward. The CEO mentioned on the Q3 earnings call that he believed the bottom is in for pulp markets (which the market is echoing) where prices should now begin to rise although on a tentative scale. Price increases concerning NBSK he stated were down to supply imbalances where a lack of supply would act as a positive tailwind regarding pricing going forward. Be this as it may, economic uncertainty in China & Europe may continue to weigh on the 'demand' side but this remains to be seen.

Similar reasons can be given for the solid wood segment in that Mercer is waiting for demand to take hold which would improve pricing accordingly. On the lumber side, we see similar fundamentals to pulp in that supply imbalances should act as a positive tailwind when a product is needed in earnest.

When we go to the long-term chart of Mercer, we see the bullish volume trends discussed in previous commentary along with that Q3 earnings beat have helped push that monthly MACD closer to a long-term buy signal. MACD bullish crossovers are especially noteworthy on long-term charts due to the sizable amount of information that gets digested plus the dual role of the indicator (momentum & trend). Furthermore, the sustained pattern of higher lows & higher highs in this stock would give a bullish MACD crossover more substance due to the signal taking place in the direction of the underlying trend.

Liquidity Gets A Boost

Value investors may bemoan the lack of profitability in Mercer but the market overall (being a predictive mechanism) is more interested in where profitability is headed. Although forward-looking sustained strength in pulp markets would bring shares of Mercer off their lows, the market also sizes up the ramifications of sustained weakness or a gradual improvement at best. Therefore, although Mercer underwent a private offering for $200 million (at almost a 13% clip) recently, the market could welcome this endeavor as it boosts liquidity which essentially buys Mercer time in this present downcycle.

Remember, Mercer is just off the back of some key investments such as the Structurlam & Torgau purchases so these investments must have every opportunity of maximizing their value over time. Investing through downcycles brings leverage to the equation when markets turn. Both acquisitions continue to perform well concerning their integrations where the CEO believes it will be only a matter of time before shareholders see the benefits of these deals.

The integration of Torgau continues to progress well. Other shipping pallet markets remain weak on the back of a weak European economy overall, while heating pallets prices were up roughly 20% due to seasonal demand relative to Q2. Once the European economy begins to show signs of recovery we expect pallet prices to return to normal levels, allowing this asset to deliver significant shareholder value to the sale of pallets and increased lumber sales.

In addition, the integration of the Structurlam assets continues to progress as planned. We now have roughly 35% of North American mass timber production capacity, a broader range of product offerings, and a much larger geographic footprint, which gives us competitive access to the entire North American market. We continue to see strong customer interest in our mass timber products, which has made our order files stronger, and including now several large marquee projects that we’re very proud of.

At the end of Q3, Mercer reported $344 million of cash on its balance sheet along with over $300 million worth of unused revolving credit lines. This means (given Mercer's significantly improved cash balance) that the dividend is safe despite neither cash flow nor earnings being able to cover the payout at present.

Conclusion

To sum up, we may be finally beginning to see green shoots in Mercer International as pulp prices look like they have bottomed out. Given the magnitude of the moving parts in this industry (Supply/demand imbalances, high interest rates, economic uncertainty, etc.) we will continue to let Mercer's technicals guide us. Suffice it to say, that we will continue to observe share-price action where the company's upcoming Q4 earnings in February may be the trigger for a MACD technical crossover. We look forward to continued coverage.

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