I'll set out a warning here out front. These two stocks could be value traps. I own both, but I am very cognizant that just because both stocks are cheap, that doesn't mean they can't get cheaper.
Lets start with Mercer. They produce 1,400Mt of pulp from 3 mills. 2mills are in Germany (Rosenthal at 310Mt and Stendal at 620Mt), whilethe other is in Canada (Celgar at 450Mt). The Celgar operation is theleast profitable of the bunch. Celgar broke even on a Mt basis lastyear, while Stendal made about $80/Mt and Rosenthal made about $60/Mt.That was with pulp prices in the $700-$850/t range. According to a recent presentation
, Mercer is the second largest producer of NBSK pulp in the world.
As for Tembec, you get the pulp leverage, but you do have to put up with lumber, newsprint, and paperboard businesses. These are not great businesses. I fell into the lumber trap briefly in March, April and early May. It started well, but when lumber started to fall and the stocks started to drop, I bailed. It turned out to be a good decision, as lumber has continued to drop and drop and drop some more. Lumber demand is down from 18 billion board feet (bbf) in 2005 to around 10bbf today. That's just a massive drop for a commodity. And with housing starts in the United States looking ever more dismal, it seems likely that lumber will be weak for the forseeable future.
Tembec has some lumber and some newsprint. All together they are maybe a $700M revenue business for the company. At best, they break even, at worst, they take a few million dollar loss every quarter. In the first quarter they lost $9M before tax from lumber and newsprint.
So you aren't buying Tembec for the lumber or the newsprint. You are buying it for pulp. Tembec has about 1,400Mt of pulp capacity. To put that another way, ever $10/t of pulp prices moves EBITDA $14M, or0.14cents a share. That's a lot of leverage. The same goes for Mercer.
For both companies, its all NBSK and specialty pulp. Mercer produces 100% NBSK pulp. Tembec produces a majority of NBSK, along with some high end specialty pulp that should, if anything,show more strength then NBSK. These are softwood pulps that command a premium price. At this point a discussion of the nuisances of pulp is warranted.
Pulp is not all the same pulp. There is pulp derived from softwood and pulp derived from hardwood. The hardwood pulp comes, in large part, from South America. The hardwood pulp is of lower quality then the softwood pulp - it doesn't have the same strength. Tissue and papers use some of both. According to Mercer producers have lowered the quantity of NBSK to the lowest levels they can go. Thus Mercer points to any growth in papers and tissues as directly causing growth in NBSK. Apparently tissue is a fast growerthen paper as far as consumption. Mercer says that annual tissue output has been growing at 3.9% a year from 2000 t 2009. Based on one graph
Mercer has in their presentation, papers account for about 52% of total NBSK demand, whereas tissue accounts for 48%.
As far as capacity additions, there are some pulp additions coming in the next few years, but they are all hardwood. The only softwood addition, according to Mercer, isthe Bratsk mill. Mercer expects that with shutdowns, softwood supplywill remain flat or decrease. Hardwood supply is supposed to grow 2.7%from 2008-2014, but softwood is epxected to decline 0.5% from 2008 to2014.
The bottomline is this. Both companies are heavilyleveraged to pulp. Both companies are going to have enormous earningsfrom pulp when they report in July. Tembec announced on June 26th
that EBITDA would be about $50M for the quarter. That's about 50centsa share. Mercer is in the same boat, but I think their EBITDA may beeven higher.
Another way to look at it is the assets you arebuying. Mercer has a book value of $15/share.Tembec has a book valueof $10/share. These are crazy numbers for stocks trading in the lowsingle digits. Yes, the markets these companies are in are incrediblydepressed. And that's why the stocks are depressed. But the assetsare there, and some day they will be worth the value on the booksagain.
These are big gambles on the economy, and largeleverage to Asian growth. I'm not super comfortable with making betson the economy right now, but I try to hedge myself by buying gold andselling some other stocks short. Playing the long side of this tradewith a couple depressed stocks trading at a fraction of book valuedoesn't seem like a bad idea. But as I started this post, I am awarethat these could be value traps, and so I'll be keeping a close eye onboth.