Nomadic Value Investment Partners recently released its Q2 2020 Investor Letter, a copy of which you can download here. The investment firm supports enterprising individuals and families in achieving respectable long-term investment performance. You should check out Nomadic Value's top 5 stock picks for investors to buy right now, which could be the biggest winners of the stock market crash.
In the said letter, Nomadic Value highlighted a few stocks and Mercer International Inc (NASDAQ:MERC) is one of them. Mercer International Inc (NASDAQ:MERC) owns and operates three modern pulp mills. Year-to-date, Mercer International Inc (NASDAQ:MERC) stock lost 34.0% and on August 14th it had a closing price of $8.05. Here is what Nomadic Value said:
"We made a small position in the Northern Bleached Softwood Kraft (NBSK) producer Mercer International (MERC) at quarter’s end. MERC owns NBSK pulp mills in Germany and Canada, a lumber mill in Germany, and an Indian Sandalwood plantation in Western Australia. NBSK pulp is used in paper and tissue manufacturing due to its high strength but soft feel. "Market NBSK” is sold and shipped all over the world to manufacturers and happens to be one of the most volatile commodities in the world. While initially a boon to prices, a great inventory stocking pre- and during COVID’s Q1 peak has not ultimately been kind to market pulp prices following, and “days of inventory” outstanding is at a historic level. In less than one year, the industry went from record prices and cash flows to battening down the hatches by significantly curtailing production. This curtailment should have market balancing effects over the next six months to a year. Interestingly, this time around older mills in British Columbia may not come back given issues of fiber supply in combination with increasingly unattractive CAPEX required to re-start production. Market experts don’t see a chance for new capacity additions until at least 2022, and realistically it could be even farther out before truly competitive lowcost supply gets added in the industry. There’s a strong chance that NBSK prices swing much higher as this supply/demand balance plays out over the near to mid-term.
Given that industry backdrop, we like where MERC sits. The company owns some of the newest mills in the industry, a unique position in Germany being the only pulp producer in the country, and a seasoned management team that’s been executing since the company’s formation in the early 2000’s. I was specifically impressed listening to the CEO discuss operational efforts taken due to COVID. The management team is focused on mitigating risk. They’ve cut the dividend, deferred discretionary CAPEX, and are 100% focused on employee safety as events unfold 12. The company will likely generate positive cash flow this year (something most competitors won’t do) and there aren’t any near-term maturities of debt.
MERC has sponsorship. Specifically, the Chairman (founder) and CEO (C-suite since MERC’s founding) both own a substantial number of shares, and there’s a concentrated group of long-term, mindful owners on the shareholder roster. Capital allocation has been an impressive mix of waiting to buy assets at cyclically low prices, strong execution with facility upgrades (which reduces unexpected downtime relative to peers) and returning capital substantially but sustainably. Currently, management is expanding lumber production in their Germanybased mill. We like this expansion given the proximity to and near monopoly on the lowest cost fiber supply in the EU. Given significant beetle damage across the region, we expect MERC to realize cost advantages leading to a furthering of exports to the US and China over the next few years.
We are fortunate to have a couple decades of high-quality data on MERC, adding confidence when valuing the company on a range of NBSK pricing and input cost assumptions. When we normalize cash flows, add a bit of growth to production, and capitalize at a very reasonable multiple, we get to a stock price that’s worth roughly 80% to 100% higher than today’s price. The question, as always with cyclicals, is timing. We could be early-- quite painfully early. However, we believe the probability is very low that when looking ahead NBSK prices and MERC’s cash flows stay depressed over a full 5-year period. NBSK prices are way too volatile for that, and Asian demand is expected to increase despite the global recession."
In Q1 2020, the number of bullish hedge fund positions on Mercer International Inc (NASDAQ:MERC) stock decreased by about 29% from the previous quarter (see the chart here), so a number of other hedge fund managers don't seem to agree with Mercer International's growth potential. Our calculations showed that Mercer International Inc (NASDAQ:MERC) isn't ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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