Mercer International (NASDAQ: MERC)

Mercer International (NASDAQ: MERC)

Analysts: Jake Stoiber, Yichen Sun, Tom Van Spankeren, Jeffrey Li

Presented April 7th, 2015

RECOMMENDATION: WATCH

Company Overview: Mercer international is a producer of northern bleached softwood kraft “NBSK”, considered to be a premium grade because of its strength, length of fibers, and flexibility. This pulp product is the sold to companies who produce paperboard, tissue, or specialty papers. MERC owns and operates three pulp mills. 2 mills, the Rosenthal and Stendal mill, are located in Germany, while the other mill, the Celgar mill, is located in Canada. Merc is the sole NBSK producer in Germany, which is the largest market for pulp in Europe. In addition, Mercer sells byproducts from the production of pulp, including chemicals and energy. The Sale of byproducts accounts for close to 10% of its revenues, and costs them very little to produce.

Macroeconomic and Industry Overview: The average growth in demand for NBSK has grown about 1% per annum in the past 10 years. Emerging markets now make up the majority of demand (51%) for the product, with countries such as China having an 11% growth rate in demand over the past 10 years. The end use of NBSK has changed dramatically in the past 10 years as we have seen a decline in the paper and printing industry. Tissue and specialty papers now make up 70% of the end use as compared to 39% in 2003. The company’s revenues and costs are cyclical in nature. In good times, especially when the real estate market its having success, supply of woodchips from sawmills is high, making the cost of raw materials lower. Furthermore, using woodchips when in supply is the cheaper alternative to cutting your own logs.

Financial Analysis, Projection, and Valuation: For the financial analysis of MERC, a discounted cash flow analysis and a comparable companies analysis was used. Key competitors listed in the company’s most recent annual report were used to determine comparable companies. These companies were then checked using CapitalIQ software. From there, multiples were selected and weighted, and an implied stock price of $24.04 was determined. For the DCF model, our discounted rate was calculated to be 10.5% (8.5% WACC and 2.0% business risk premium), and a terminal growth rate of 2.0% was applied. This calculated an implied share price of $ 15.92

Risks: Mercer has a high degree of interest rate risk. This stems from an October, 2013 change to reporting in dollars versus euros. With their operations occurring in Canadian dollars and Euros, they face an interest rate risk. It is estimated that a $0.01 increase in the value of the dollar versus the CAD and the Euro will decrease reported operating expense by $8 million dollars. Furthermore, the company faces multiple risks in regards to cost of goods sold. The chemical prices and raw material prices are cyclical like our business, and MERC has reported losses in the past often in part due to difficult of controlling costs.

Recommendation: Our recommendation is to WATCH the company at its current stock price of $15.23. With recent volatility of EUR/USD, and with the uncertainty of whether this company can continue to acquire/expand, we believe that a hold is currently appropriate.