May 4, 2018
Executives
David Gandossi – President and Chief Executive Officer David Ure – Senior Vice President, Finance, Chief Financial Officer and Secretary
Analysts
Hamir Patel – CIBC Capital Markets Sean Steuart – TD Securities Joe Pratt – Stifel Jason Doyle – Lawndale Capital Management Charan Sanghera – RBC Capital Markets Adam Zirkin – Knighthead DeForest Hinman – Walthausen & Company Dan Jacome – Sidothi & Company
Operator
Good morning, and welcome to the Mercer International’s First Quarter 2018 Earnings Conference Call. On the call today is David Gandossi, President and Chief Executive Officer of Mercer International; and David Ure, Senior Vice President, Finance, Chief Financial Officer and Secretary.
I’ll now hand the call over to David Ure.
David Ure
Good morning, everyone. I’ll begin by taking a few minutes to speak about the financial highlights of the quarter, and then I’ll pass the call to David to discuss the markets, our operational performance, strategic activities and our outlook into Q2.
Please note that in this morning’s conference call, we will make forward-looking statements. And according to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, I’d like to call your attention to the risks related to these statements, which are more fully described in our press release and in the company’s filings with the Securities and Exchange Commission.
For the second quarter in a row, we’ve achieved a new quarterly EBITDA record. This result was primarily due to steady pulp demand growth driving record pulp prices combined with solid production performance.
Q1 consolidated EBITDA was $99.4 million compared to $89.5 million in Q4. When compared to Q4, our Q1 results are highlighted by higher pulp prices which were partially offset by higher fiber costs.
In terms of business segments, our Pulp segment contributed $95.6 million of EBITDA, and our Wood Products segment contributed EBITDA of $4.7 million. You can find additional segment disclosures in our 10-Q.
In Q1 the average European pulp list price was up $100 a tonne and almost $50 in China. Compared to Q4 higher pulp prices positively impacted EBITDA by almost $24 million.
David will have more to say about the markets in a moment. Our pulp sales volume totaled about 367,000 tonnes which was similar to Q4.
Total consolidated electricity sales were down about 30 gigawatt hours relative to Q4 at 196 gigawatt hours. In addition, we sold the equivalent of about 150 million board feet of lumber in the quarter with about 27% of this volume being sold to the U.S.
market. We reported net income of $25.6 million for the quarter or $0.39 per share compared to net income of $41.7 million or $0.64 a share in Q4.
Our Q1 net income included about $21.5 million of expenses related to our recent senior note refinancing, and by approximately $7 million for the NAFTA legal cost award, which combined reduced our earnings by about $0.44 per basic share. Our Q1 interest expense was $12.1 million compared to $13.9 million in Q1 2017, a benefit of the bond refinancings completed in the first few days of the quarter.
Income tax expense in the quarter was $9.6 million of which approximately $4.8 million was current. Current taxes reflect our continued use of tax assets to shield cash taxes.
As you know, the U.S. Federal Government recently made significant changes to the tax code and most notably for Mercer, some of the changes impact how foreign operations are taxed.
We continue to believe that the new rules will not result in any additional cash taxes in the current year, as any tax liabilities will be reduced by our tax assets. Turning to cash flow, our cash balance excluding restricted cash increased by about $17 million in Q1 compared with decrease in cash during Q4 of approximately $14 million.
The increase in cash in the quarter was driven by strong operating results highlighted by our EBITDA being only partially offset by a modest working capital increase. Higher accounts receivable is a result of higher pulp and lumber prices along with higher inventory levels due to increased spare parts as the mills prepare for their maintenance shuts, and increased raw materials inventory were essentially offset by higher payables which included our NAFTA settlement.
Capital expenditures grew approximately $16.4 million during the quarter. This spending was mostly at Celgar and Friesau and included projects to upgrade the saw line at Friesau, improved Celgar’s digester performance, and upgrades Celgar’s woodroom crane.
Our cash outflows in the quarter also included our quarterly $8.1 million dividend payment. In January, we refinanced $300 million of our 7.75% senior notes due in 2022 with $300 million of 5.5% senior notes due in 2026.
Due to the prescribed notice period, the new issue was completed in December and the redemption of 2022 senior notes was completed in early January. As a result, we have recorded $21.5 million of related expenses that include $17.4 million of early redemption expense, and the write-off of $4.1 million of deferred financing fees.
On a trailing 12-month basis, our net debt is about 1.6 times EBITDA which has decreased noticeably relative to Q4 primarily due to our strong Q1 EBITDA. And you all have seen from our press release yesterday that our Board has continued our quarterly dividend of $0.125 for shareholders of record on June 27, for which payment will be made on July 6, 2018.
That ends my overview of the financial results. And I’ll tell – turn the call over to David Gandossi to discuss market conditions, our operational performance and strategic activities.
David Gandossi
Thanks, Dave, and good morning, everyone. We’re pleased to report another record offsetting result for Mercer.
Our mills generally ran well, the markets for our products are particularly strong, and we made solid progress on our capital expenditure program. We produced 364,000 tonnes of pulp this quarter, off only modestly when compared to recent quarters as a result of some minor upsets earlier in the quarter that temporarily impacted both pulp and energy production.
However, the mills ran very well for the balance of the quarter. Our Friesau sawmill also performed well this quarter producing 103 million board feet of lumber on a two shift basis and $4.7 million of EBITDA.
In addition, the sawmill allowed us to achieve about $3.5 million of synergies in Q1 which is on top of the almost $7 million of synergies we achieved in 2017. Pulp markets continued to exhibit the tightness created by steady demand growth combined with supply constraints.
In Europe, Q1 list prices averaged $1,097 per tonne, compared to $997 per tonne in Q4. The European market continues to be exceptionally tight with limited spot tonnes available, and as a result, we continue to see upward pricing pressure.
April’s list price is $1,170 per tonne, an announcement premier indicating $1,200 per tonne. In China, Q1 average prices have remained steady at almost $50 per tonne higher than Q4.
New business in China continues to transact at near record levels between $880 per tonne and $910 per tonne on a net-net basis. In our view, the tightness in the pulp markets is simply reflecting steady demand from paper producers, combined with constrained global NBSK supply.
In addition to this macro situation there are currently a few other factors we’ve discussed before, but which I’ll review again today. Producer and consumer inventories remain very low.
The industry is beginning to reflect its age with rising levels of unscheduled downtime, and China’s recent environmental initiatives include the closure of highly polluting agricultural pulp and paper mills along with limitations on the import of recycled fiber. These factories are all combining to create a noticeable supply tension in the market.
Finally, as we move into Q2, there may be further restrictions on the supply of pulp due to the upcoming scheduled maintenance season in our industry. All market indicators are pointing to continued strong demand through Q2.
While, we are monitoring recent NBSK capacity additions, the incremental capacity that’s come online in the last two years has not yet negatively impacted the market. Lumber markets are also very strong with prices in the U.S.
at record levels. The Random Lengths U.S.
benchmark for Western S-P-F number 2 and Better averaged $514 per thousand board feet in Q1, which is up roughly $50 from Q4. In the European lumber markets we are also seeing continued steady demand and strong pricing.
Relative to Q4, our fiber costs were up this quarter, primarily a result of warm and wet winter weather conditions that negatively impacted harvesting and wood logistics in both Germany and Western Canada. But we were not forced to alter our operations like some producers, we did experience some wood cost escalations due to shortages in some regions.
Looking forward, we expect wood prices to decrease slightly in Q2 as weather conditions for harvesting improved, and we begin to access some lower-cost wood, including some regions from storm fallen wood. Logistics channels for products operated well during the quarter, we are however monitoring potential labor issues at the Canadian Pacific Railway, which services our Celgar mill.
Currently two of the unions are preparing to vote on a contract offer. And while we’re optimistic, there will be – there will not be any distractions toward service.
We do have contingency plans in place. And as we have mentioned on pervious calls, we have an attractive CapEx scheduled plan for 2018.
We’re investing $40 million in our saw mill to improve our lumber yields and great outturn with modifications to the saw line and the planer mill. We also will be investing about $20 million in our Celgar mill’s digester – chip in-feeds and digester screens to improve its speed and eliminate the production bottleneck.
Company-wide, we expect to spend approximately $90 million on CapEx in 2018. In addition, we plan to expand our customized railcar fleet in Germany.
This railcar program is a continuation of our initiatives to replace shorter-term equipment leases and rental agreements with much more efficient equipment. With respect to our NAFTA case, we were very disappointed with the tribunals decision given our desire for fair treatment relative to other energy producers of British Columbia.
I would also like to remind everyone about the timing of our annual mill maintenance shuts for the balance of the year. We will complete the major maintenance shuts for both Celgar and Stendal in Q2.
Stendal shut has been safely and successfully completed. The mill was down for 12 days, and Celgar will be down for 14 days starting in early June.
In addition, Celgar shut include all of its original electrical turbine. This is a major project that is required about every 10 years and will keep the turbine offline for approximately three months.
Consequently you can expect heavy maintenance spending in Q2 and reduction of energy sales to Stendal’s turbine maintenance. As usual, we will complete the Rosenthal shut in Q3 followed by a three-day shut at Stendal also in Q3.
In summing things up, our first quarter was another step forward in successfully executing our strategic plan, which is built on delivering results for shareholders from world class assets and building a platform for sustainable, profitable growth. Once this quarterly results illustrate the quality of our operations and the resources we invest to keep them among industry leaders and efficiency, safety and reliability.
Our disciplined search for growth opportunities is framed by Mercer’s core competencies. And we continue to improve and define these every quarter as well.
We’re very pleased we were able to report another record operating result for the first quarter and the way these results highlight our long-term approach to creating value for shareholders. So that’s the conclusion of our prepared remarks.
I’ll now turn the call back to the operator so we can open the call up for questions. Thank you.
Operator
[Operator Instructions] Your first question comes from the line of Hamir Patel from CIBC Capital Markets. Go ahead, please, your line is open.
Hamir Patel
Hi, good morning. Dave, [indiscernible] recently recorded that Mercer was going to produce, I think, it’s 20,000 tonnes of unbleached in Q2.
Can you speak to maybe how the pricing and margins of that product compares to NBSK? And should we expect that similar level of volume going forward for the rest of the year?
David Ure
Yes, it’s an interesting time for unbleached kraft. I mean, it’s not typically a big market and typically trades at a fair discount to NBSK.
But just at the moment because of some of the shortages in Asia relating to recycle, the pricing for UBK is pretty close to NBSK. Our run is really just an opportunity to capture some value.
So they’re rough numbers. If you don’t run a bleach plant in a facility like Celgar, you can save about $80 a tonne.
There’s about a 6% yield improvement when you’re making unbleached. Taking the bleach plant down, we’re taking it down just on the front end of our annual maintenance shut which will give us more time to conduct the maintenance in that area of the plant without having to push over time and those kinds of issues.
So it was just a nice, tidy, opportunistic situation for us. I’m not sure what the future holds, it will all depend on the pricing of that grade, but for now it’s a nice little win for us.
Hamir Patel
Thanks, that’s helpful. And we saw some reports about ongoing European grading issues for the imports.
Just curious what are you seeing there? Is that changing?
How you think about the level of volumes that you would want to sell into the U.S.? And are you seeing other producers may be pull back?
David Ure
Yes, I think, it’s been a real issue for European producers for sure. It might be a little technical for the call, but for those who understand these things.
What’s happening in the U.S. is really limiting the European’s ability to send, what we call, split 2x4s into the U.S.
market. So most U.S.
sawmills grow. Because we have bigger logs in Europe, higher-quality timbers, we tend to produce 2x8s on the sawline, and then we cut them into 2x4s in the planar lines.
And these are called splits. And the nature of the product makes it very difficult for graders to identify spike knots, which are the little knots that are going traverse through the board, and the grading agencies have been really catching most European in the U.S.
ports on that issue. We got caught up in that a bit in the fourth quarter.
We had some product that we needed – we had to re-grade. And as a result, we’ve limited our production of split 2x4s.
We still have, as you saw, 25% of retails volume going into the U.S. market, but we’re just – we’re not selling the splits, which is a little disappointing for us.
Some of the capital upgrades we’re doing will eliminate or should help to alleviate that problem. So we’ll be putting a horizontal saw in the sawline and better optical grading, it’ll give us a better return.
We’re not in the penalty box like some of the other European producers. I mean, Mercer took the situation very seriously.
We enhanced our grading capabilities; put extra guys on the line, slow the line down, that kind of thing. We don’t have the optical grading yet.
It’s all manual. So we haven’t had any issues for touchwood, haven’t had any issues for well over three months now.
So I think we’re through the – through that. But there are others, other European producers that are all struggling on exactly the same issue.
And there’s been few who haven’t really adjusted their grading, and I didn’t take it as seriously, and I’ve even heard of one European producers that’s in the penalty box for a number of months, build their chips into U.S. at all.
Hamir Patel
Sure enough, thanks. Thanks, Dave.
That’s all I have for now, I’ll get back in the queue.
David Ure
Okay. Thanks, Hamir.
Operator
Your next question comes from Sean Steuart of TD Securities. Go ahead, please, your line is open.
Sean Steuart
Thanks. Good morning, guys.
Couple of questions. First on fiber costs.
You guys noted the inflation in both BC and Germany in Q1. You indicated for Q2 you expect some moderate relief.
And I suspect a lot of that’s weather related. Just wondering if you can contrast the relative magnitude of release you might expect for Celgar versus the German mills.
David Gandossi
I think Celgar’s going to be a little bit more unpredictable. A lot of the sawmillers got behind in the – due to the weather.
And so the focus to catch up is on saw logs. It’s not the pulp logs that we would traditionally be sourcing from our closer, and regions are being removed.
The focus is really to get at the saw logs so that the sawmills can get their inventories back up. It’s like a resource problem, you’ve heard about the trucking issues and so on.
So we’re working our way through that, and I’m expecting things to get better as we move towards summer, but it’s hard to predict. And over in Europe, the higher cost really relate to Stendal.
So with Friesau related to Rosenthal now, looking at the marginal cost curve for Rosenthal, I mean, its flat right over into the fourth quartile. And it’s because we don’t need to buy any marginally higher-cost wood, because Friesau producing a really nice supply for it.
But Stendal struggled a bit in the Baltics with cost inflation. And you may know the – a lot of the Scandinavians release struggled with weather.
We had similar weather here in Germany. We didn’t have to curtail our operations the way they did up north, but they put pressure on that intermediate market.
As things dry out, and everybody gets back to work in Scandinavia, we’re hoping the pressure in the Baltics subsides, and Stendal’s fiber cost should come down as well.
Sean Steuart
Relatively moderate relief would be expected in Q2, I guess on a sequential basis.
David Gandossi
Yes. Exactly, yes.
It’s hard to – I mean, it’s not – it’s hard to say, Sean. One of the things that has happened over here though is, there’ been some pretty big storms.
So there’s a lot of wood out there that needs to come out, and we’re waiting to see how that impacts the price. It would get positive actually.
Sean Steuart
Got it. Second question, on sustainability of NBSK momentum, and I tend to agree with your view that the capacity coming probably isn’t enough to knock the legs out from under this market.
But I’m wondering if you can comment on – I guess, it’s a potential for demand destruction from margins being squeezed for non-integrated papermakers, especially in the tissue side and Mercer in North America, maybe, than another regions, we’ve seen significant margin contraction for some of these companies. Any thoughts on how that could affect things over the near to midterm for pulp pricing?
David Gandossi
Yes, it’s a great question. Some things to think about, so the premium rating guys, their margins are actually not bad, I mean, they’re better than they’ve been for a long time.
I mean, there’s been a lot of price improvement on a lot of grades. I think the tough spot, as you mentioned is the tissue.
And I think the reason for that is that typically in that sector prices are established sort of six months in advance. So they’re not – they haven’t really been able to keep up with – or really get any price increases to offset the fiber cost increases they’re having.
Having said that, I mean, probably one of worst things that could happen to them as they go into their price discussions in June is to have any kind of reduction in NBSK pricing. So they need to hold the price so they can push that through their product; and if they’re successful, or – that will – that would – obviously, they’re going to push really hard for that.
So I don’t see that demand destruction yet. I don’t really – I don’t – I mean, it’s not – I mean, anytime we have fiber inflation like this, I mean, it’s got to be hurting some, but by and large, I don’t think it’s going to happen here in the near-term.
Sean Steuart
Okay. Thanks for that detail.
That’s all I have, guys.
Operator
Your next question comes from Joe Pratt with Stifel. Go ahead, please, your line is open.
Joe Pratt
Yes. Good morning Dave and Dave.
SCA comes on in July, I believe, with 450,000 tonnes?
David Gandossi
Yes, probably June. Yes, they are down now.
Joe Pratt
Okay. And what about the Äänekoski, Metsä situation?
Is that fully in the market, or are they still ramping that production?
David Gandossi
I think it’s pretty much and I think it’s running well, Joe. So it’s in the market, for the rest of the listeners that mill came online in August of last year, so it’s in the market, it’s part of what we’re dealing with today and I don’t think they are having any issues getting their pulp placed.
It’s an incredible time in Europe, there’s just no inventory anywhere and there is no inventory, we don’t have any inventory, or our customers don’t have any inventory, we can’t sell a spot tonne to anybody because we’ve got to meet all our contract commitments. There’s no inventory in the ports and China as you know is in a similar situation.
So Äänekoski, we are all sold out right now. The SCA mill starts up in June or maybe early July as you say for this year that’s a net 100,000 tonne add for 2018 which is dropping the bucket.
Joe Pratt
And moreover Dave, we are going to be in that 450,000 add?
David Gandossi
Well, they’re down for six weeks, not making anything right now. So we will get them on annual basis.
Joe Pratt
Yes, I got it.
David Gandossi
So I don’t – just don’t see that being a big deal for this year.
Joe Pratt
Okay. Any other big projects announced after SCA coming onstream?
David Gandossi
There’s still the Belarus mill that never started up. That was a joint project between Chinese equipment manufacturer and the Belarus Government, that mill goes Svetlogorsky.
Industry rumor is they’ve got some pretty serious issues over there. And I don’t know if and when it will run and to what extent it will be market versus integrated.
Joe Pratt
Okay. Next question, quick question.
What was – I apologize for not having read your 10-K. What was the EBITDA for the lumber business last year?
David Gandossi
It’s about $9 million.
Joe Pratt
And do you expect that to be –
David Ure
With $7 million of synergies as well at the Rosenthal mill. And that was –
Joe Pratt
Okay. Do you expect that EBITDA to grow this year?
David Gandossi
Yes, for sure. And as we do our capital improvements, I think it’ll grow quite significantly.
I’ve said on previous calls that all of the capital we’re spending at Friesau will be well under our three-year payback hurdle rate.
Joe Pratt
Okay. And then have you made a decision about any de novo sawmill buildings?
David Ure
About which building?
Joe Pratt
Well, building new sawmill somewhere. You’ve discussed that probably in the past.
David Ure
Sorry, Joe, just didn’t hear you well. Yes, so we’ve been working on the feasibility of putting a sawmill in at Stendal.
We see tremendous synergies in that. It looks like a really attractive opportunity for us.
The devil’s in the detail. We’ve got to finalize all our engineering.
We’re doing all the fiber studies, logistic studies to make sure that we can cope with all of those changes. But this looks quite promising.
Joe Pratt
Okay. And if you made the go-ahead, I mean, for the next couple of years while you’re building that up, what would be the annual increment to capital expenditures from that?
David Gandossi
Well, I mean, it’s – if we build it in probably 18 months, and I think, it looks like the total cost for that mill will be, if we do it, would be somewhere around EUR160 million to EUR165 million.
Joe Pratt
Okay. Okay, and lastly, you had a nice big jump in cash from December 31 to March 31.
How did that come about?
David Gandossi
Well, a lot of it’s pulp pricing, Joe, and a good performance, and then as the working capital moves as well, harvesting some working capital from winter inventories, those kinds of things.
Joe Pratt
Okay, I am done. Thank you for answering my questions.
David Ure
Thank you, Joe.
Operator
Your next question comes from Jason Doyle with Lawndale Capital Management. Go ahead, please, your line is open.
Jason Doyle
Hey, guys, just a quick one. And I apologize if this has already been covered, but I got disconnected briefly.
But can you give us the production and sales number by mill?
David Gandossi
Yes, I can do that, Jason. So in thousands of tonnes – let’s start with production volume first in thousands of tonnes.
Rosenthal, 90.2; Stendal 158.2 and Celgar, 116.1. Sales volumes; Rosenthal, 91.9; Stendal, 161.7; and Celgar, 113.5.
Jason Doyle
Okay, great that’s it from me. Thanks.
Operator
Your next question comes from the line of Charan Sanghera with RBC Capital Markets. Go ahead, please, your line is open.
Charan Sanghera
Hi, guys, good morning. Just touching a bit on Joe’s question earlier on industry capacity adds.
I just – looking at your Q4 press release and you had – you’re saying 1 million incremental tonnage in the industry for NBSK in 2018. And then with the yesterday’s press release, you’re saying it’s about 0.5 million tonnes.
It’s that the Belarus – are guys being in the Belarus mill?
David Gandossi
Belarus – yes, the 1 million that we reported in the fourth quarter, we were expecting 250,000 of Belarus tonnes. And then the other component is all these unexpected shuts that we’ve been experiencing.
Charan Sanghera
Got it, got it. So, what do you, guys – looking at those numbers are, that’s kind of implying growth rate for NBSK and demand of about 3% to 4%.
Would that be fair to say?
David Gandossi
I’m not sure demand is growing quite pace. I think it’s more in the 250,000 to 300, 000 tonne range, like 1.5% to maximum 2% probably.
Charan Sanghera
Okay. So then, I guess, the offset is just some of the outages.
And that’s why you kind of feel that the market would stay tighter than it would imply with the nameplate capacity?
David Ure
Yes. I mean, it’s – so I’m just giving you the demand growth that’s sort of a statistically developed number.
But the other drivers that I keep talking about are things like absence of agricultural pulp and paper in China driving more demand for paper products that are made from pulp, so you get swings, the diminishing quality of recycled fiber that creates demand for more virgin fiber. And then it’s the aging industry is becoming a much more apparent issue to – last year it was a pretty tough year for a lot of these older mills.
And this year, it looks like it’s going to be the same. So there’s a number of other drivers in this whole thing other than just the straight demand number.
And having said that, I think, demand’s not a – demand growth is not a linear thing. It’s – because as the – strong economic growth conditions, the size of the developing economies, and how rapidly people are progressing into them, it’s almost a game changer in my mind in a lot of these specialty products.
Charan Sanghera
Okay. Just another quick question on pricing dynamics between North America and China.
Recent Ritchie article was saying that softwood pulp prices were easier to push in North America, and there’s pushback in China. I’m just wondering if you would comment on what you guys are seeing in that regard.
David Gandossi
Well, China has been pretty flat from a pricing perspective, but it’s also been the highest-margin market for pulp producers globally. So that makes sense to me.
We’ve been catching up in the other markets. And China is a strong market.
It’s not like – I mean, I think we’ve pushed it hard early and got it up, and that’s just what it’s going to stay for a while.
Charan Sanghera
So it’s not a signal might be turning, but you’re just maybe got a bit ahead of it.
David Gandossi
I really don’t think so at this point. You can’t see the softness with regards to price that diminish at all right now.
Charan Sanghera
Got it, got it. All right, that’s it from me.
Thanks, guys.
Operator
Your next question comes from the line of Adam Zirkin with Knighthead. Go ahead, please, your line is open.
Adam Zirkin
Hey, gentleman, really congratulations on a great quarter. David, a question for you; the production numbers at Stendal, in particular, I think looks, perhaps, a little light for a zero maintenance quarter.
Can you, perhaps, give some insight as to what might have been happening there? I think the number was, sort of, in the low 170s last year, right?
David Gandossi
Yes. Stendal doesn’t miss very often, Adam.
And so without making excuses, what happened was, on December 23, in the town of Stendal, which is some kilometers away from our mill, there was a transformer that failed, which took the whole grid down, which crashed our mill. And so if you imagine a belt running across a paper machine, and the drier at full speed, and then all of a sudden, everything just stops.
And I guess, what it did is it torqued one of the rubber liners on a big press roll. So these press rolls are like a 90-tonne roll, and it’s got a 0.5-inch rubber sleeve all the way around it.
And when the belt that runs over that thing stopped instantly, it started a delamination of that rubber from the roll. And as we were running early in the year, all of a sudden we had a catastrophic failure of that press roll that required us to take the mill down, pull that roll out, repair it, put it back in.
And so it was really, primarily, that issue that impacted the quarter.
Adam Zirkin
Just out of curiosity and perhaps, this is a question I should know the answer to or illustrate some misunderstanding. The mill powers itself, right?
So why is it so susceptible to a grid failure?
David Gandossi
Well, you can’t – island it by itself instantly. These doesn’t work that way, like, we’re taking power from the grid, and we’re sending power out to the grid.
We don’t run halfway.
Adam Zirkin
Got you. Over in Europe –
David Gandossi
Unless you’re running on an islanded basis, but under normal conditions you wouldn’t.
Adam Zirkin
You wouldn’t, got it. I think on the call last quarter, and it was certainly in the middle of winter, we talked a bit about fiber availability in Europe, given the weather.
Have all of those issues cleared out at this point? Are there any fiber availability issues, frankly, in Europe or anywhere else in the system?
David Gandossi
We’ve been okay. We’ve got some – we haven’t had any curtailments, like, there was quite a few curtailments up north.
The weather was so warm in the first few months of the year that you just – in a lot of parts of areas of forest line you just can’t go into. One of our strategies has been to create more paved areas very close to the mill where we store roundwood, down to this extent I’m referring to where we store more wood that we can get at, and we also have our strong train logistics.
So when we can’t get into the forest near the mill, we will use our blocktrains to go further way to bring in wood from areas where it can be collected. And that tends to be slightly higher wood.
It’s not that the wood in the region, per se, has got more expensive. It’s just the logistics cost that took to keep the mill running.
And I think the signal going forward for Germany is, there’s been a lot of storm wood available, and as that starts coming out, that should – we should see some cost reductions because of the volume of wood that’s going to have to hit the market at a very quick point of time. So we’ll be taking advantage of that.
Adam Zirkin
Got it. David, if I could just move to capital allocation for a moment.
Obviously, you’re sitting on $215 million of cash, right? When it’s willing that you’ll generate considerably more if these markets hold as we go through the year?
You left the dividend flat. Is the principal reason there that you’re focused on looking at the economics of this new sawmill, or how – if not that, what is, sort of, holding you back on, perhaps, distributing more cash to the shareholders?
David Ure
Yes, it’s a fair question, Adam. And I think you can take some hints from the type of comments I make when I talk about our platform for growth.
We describe ourselves as a growth company. We describe ourselves as having very strong core competencies on execution, on continuous improvement, cost reduction, running world-class assets and so on.
And in our search for growth, what we’re finding is, I mean, what we all know, at this point in the cycle, everything is really – every acquisition you could imagine is going to be very expensive. And we’re disciplined.
It’s not going to create shareholder value by paying a full price for an asset. So we’ve been studying very hard to see, to determine the feasibility of growth organically.
And we see great room for improvement on the sawmill that we purchased. We think that a sawmill at Stendal makes a ton of sense, considering all of the synergies that go along with having a big sawmill beside a big pulp mill.
And we also have incremental pulp capacity at all three mills. And what I like about incremental pulp capacity is, typically, these are three-year paybacks or better, because you don’t have any fixed cost to make those incremental tonnes of pulp.
And you get energy benefits from them, from every tonne as well. So I think we’ve got some pretty exciting growth opportunities from internal spending.
We’re working hard on proving that out and making sure that all of these things are dialed in. Because I say we always execute, we get things done the way we say we’re going to get them done.
So I can’t announce them today. But we’re working hard on it.
And in the context of that opportunity, our board felt that it – now it’s not the time to make any changes to our capital allocation strategy.
Adam Zirkin
Understood. And I appreciate the tender.
With respect to the sawmill that your referenced, I think, earlier in the call, you thought the total cost there at Stendal would be EUR160 million to EUR165 million. Can you give a sense of what the – at least, perhaps, current lumber prices, what the economics of that sort of project would be in terms of cash flow or EBITDA generation or some metric that we can –
David Ure
Well, I’ve got to be careful about guidance, but I will repeat. Discretionary capital for Mercer is three-year payback or better.
So you can imagine that kind of capital all with the three-year payback or better.
Adam Zirkin
Understood, understood. That’s very helpful.
On EBITDA or on cash flow?
David Ure
On EBITDA.
Adam Zirkin
Thank you, David. That’s all I have.
Operator
[Operator Instructions] Your next question comes from DeForest Hinman with Walthausen & Company. Go ahead, please, your line is open.
DeForest Hinman
Hey, thanks for taking my questions. Going back to the use of capital.
We have this new group, Mercer Holts [ph]. And it sounded like we’re using a unit to go, and I guess, purchase everything in terms of saw logs and pulp logs.
And then we’ve been making these railcar investments as well. Is this thought up in the Stendal mill, kind of, a sawmill investment at more holistic approach to that Mercer Holts [ph] and some of the economics we have been seeing in that business early on?
David Gandossi
Well, we think about how to approach that. And Mercer Holts [ph] was created as a result of the way we think about our procurement and logistics strategy.
So we wanted to have one voice in the market. We didn’t want to have a northern and a southern unit.
We’re a little disconnected to each other. So Mercer Holts [ph] was bringing together all of the strengths and all of the individuals in the Mercer procurement logistics organizations and putting them into one.
And they service both saw mills and pulp mills. And we procured wood on behalf of others as well.
And we have our partnership with Mondi, as you know, what we call, wood2m. So it’s – that whole unit is an optimization and a strategic-thinking procurement organization or logistics organization, which helps us ensure that we get wood at the right price at the right time and at the right place, that kind of thing.
The sawmill situation is, as you know, the yield of a saw log through a sawmill is 35%, 40% residual fiber. You can only make 60% to 65% lumber out of the saw log, the rest goes to a pulp mill.
So if you imagine a big mill like Stendal, and it’s got a procurement circle for the roundwood that it needs, which are not saw logs by the way, we call it industrial wood. And it’s – and you have a cost curve for wood that you need to feed the mill, and you’ve got – at the left-hand side, you’ve got your lowest-cost wood; at the right-hand side, you’ve got your highest-cost wood.
When you build a sawmill or have a sawmill beside a pulp mill, all of a sudden, you have a new source of fiber. You procure saw logs that you didn’t use to buy, so your procurement circle can be closer into your mill.
And you make lumber, and you make a profit, and then you have the residual fiber that replaces your highest-cost fiber that used to bring in from somewhere else. And that’s why, like I said earlier, marginal cost curve for Rosenthal kind of creeps up, and then it goes flat all the way to the right-hand side, because we don’t have to go very far to get high-cost wood.
We’ve got enough wood right around the chimneys, and that’s what we’re trying to recreate at Stendal. And it’s just – we’re just buying a different type of log now, one that we haven’t previously been buying and turning it into lumber and having our residuals to feed the pulp mill and displace higher-cost wood.
DeForest Hinman
Okay, that’s helpful from an understanding. And then you touched briefly on the railcar investments.
Can you talk about the cadence of that CapEx, and how those leases fall off, I guess, over the next year, two years? How meaningful is that?
And then some of the cost savings involved.
David Gandossi
Yes. So what we’re doing – so maybe a starting way to think about it is, we’re – on any given day there may be 600 railcars on-track securing products for Mercer, and 200 of them are highly efficient Mercer-design railcars that carry roughly 40% to 50% more product for the same length of train that the traditional railcars do.
The railcars that are not our specialty railcars, the regular ones that would be available on the market today, most of those are on annual rentals or shorter-term rentals. So when we replace them – when I say, we’re going to buy more efficient railcars, actually, what we do is we have them built, and we lease them from the – or the manufacturer – or the financing agent.
The lease cost is round numbers. It’s the same or less and particularly less cost for unit of transported material, because it’s a longer-term lease, and it’s a much more efficient use of the railcar.
So we’re not really putting CapEx to work, per se, it’s going to be all long-term leases. And from a cash flow cost perspective, the amount we spend on railcars won’t go up, but we’ll have 40% more railcar efficiency if you like.
And then the other piece of the equation is, if you have really efficient logistics, then you can go further away to buy wood and bring it into the local market. So we’ve got cheaper wood out in the eastern countries.
And so we’ll go there, pick that wood up, bring it into Germany, and it helps reduce the pressure on the domestic purchasing, which helps to keep the cost of the whole wood basket down, so it’s sort of a strategic benefit that we have.
DeForest Hinman
Okay. So maybe just in a different way.
So you’ve got 400 non-optimized cars. How long does it take to get those to the Mercer design that we want?
David Gandossi
Yes. So those will start coming in by middle of next year.
And by the end of the year, we’ll have another 250 railcars on top of the 200 that we have today.
DeForest Hinman
Okay, that’s helpful. And on the sawmill; I’m looking at my old notes, Friesau, we said, we’re going to ramp it up.
Our goal is to hit 300 million to 330 million on an annualized basis. Your production in the first quarter was 102 million board feet.
Can you update us on what that annual production capacity is, I guess, for 2018 because the numbers aren’t driving anymore with that strong ramp?
David Gandossi
Yes, we think of the capacity of that mill somewhere in the 450 million to 460 million board feet of lumber per year and based on this current configuration, running on two shifts.
DeForest Hinman
Okay. And then you touched briefly, once again, on OCC in China, there’s lots of different reports out there.
Do you – and then once again this is kind of – I’m asking your opinion on this, longer term, do you anticipate that they’ve loosen in terms of what they’re allowing in on the OCC side? Or do you see this as pretty firm, in that there’s going to be less OCC coming into China?
David Gandossi
To be super honest, of course, I’m not really qualified to answer that question. I mean, I know that the permits have been improving for OCC.
It was slow and coming, and some of the big guys who use the product in China were concerned how long it was taking to get their permits to import, but I know a lot – they’ve been getting a lot of them recently. On a net basis I don’t know what the shortfall’s going to be, or how that’s going to unfold.
I think my feeling is that China’s serious about not importing anybody else’s garbage. So as long as what’s coming in is clean and reaches the standard, they’ll be okay.
But any of the stuff that was, kind of, suboptimal, I’m pretty sure China is going to be auditing it and making sure it doesn’t arrive in their country.
DeForest Hinman
And then maybe just bigger picture, with the – just, maybe your thoughts on share price. Are people missing something with the company?
You’re down year-to-date. You had two record quarters in a row.
You spent time sometime talking about additional capacity not really being something that the market can’t deal with. Your stock’s down year-to -date.
You’re not looking to do a share repurchase.
David Ure
Forest, you are really depressing me.
DeForest Hinman
Well, we’ve been shareholders for a very long time. I would say your execution strategy has been very good.
Your balance sheet is in great shape. Just refinanced your debt.
And I think record- free cash flow, and you have a flat-holed stock. So what is everybody missing?
David Gandossi
Well, my feeling is that we got wrapped around the axle on the new capacity, and we would start looking at singular data points on supply and demand and not enough recognition of how rapidly the world is changing, and how impactful some of these bigger changes can be in our space. As I say on these calls, we’re – NBSK is a small niche market in a huge global paper basket, and there is very significant barriers to entry in this business, and there is a lot of high-cost operators to steep cost curve.
And we’ve been building Mercer to be a platform for excellence and growth with modern assets. Longer-term, I mean, I’m just a huge believer in our business strategy.
It’s just, people are seeing the speed bump in front of us with the capacity and they haven’t really seen the future all that clearly. And it will, so I’m very optimistic personally.
We’re very excited about our organic growth, because – we feel like we’ve got an opportunity to invest in markets, which are going to be really good for us in the long-term. And we have a chance to do it right and be world-class performers in both lumber and in NBSK pulp.
So, I agree with you that we’re disappointed in the share performance. But I think there is – it’s going to take – it’s just taking people a little while to see through the leaves to appreciate what the Mercer platform really is.
DeForest Hinman
Okay. And maybe just one more comment.
In the deck, does it make sense to think about putting any sort of replacement-cost metric for the mills, appraisal of the mills, I mean, even some of the stuff that’s more far out, like the Finnpulp is going to build a hypothetical giant mill in Finland. And bird in the hand versus two in the bush.
You have Mercer producing right now. Finnpulp’s going to spend, I don’t know what the number is, $1.3 billion on some big mill.
Well, you’ve got three good pretty good sized ones right now. Why isn’t the market looking at those as any type of saleable asset or a comparable versus hypothetical new capacity?
David Gandossi
Yes, it’s a great question. And you the appetite of the big paper producers to ensure they’ve got security of fiber going forward when they think about the age of the industry, the value of our assets can do nothing but go up.
I agree with you.
DeForest Hinman
Have we ever done prices of other mills for the banks?
David Gandossi
No, we don’t do that per se. I mean, we understand what it costs to put a tonne of capacity.
And we built two of our mills. We’ve looked at a lot of the other mills over the years.
But you can’t build a pulp mill for less than a $1 billion today. I mean, it would be, probably, significantly more than that depending on where you are.
And like you say, I mean, Finnpulp is making a good – it’s a development project right now. Frankly, it’s not fully developed with financing or anything close to financing.
And there’s a big question about what impact it’s going to have in the fiber market in that country. So, if we did get built, maybe they’re going to be some astronomical prices for wood, and maybe they think that’s okay because e pulp prices are going to be really high.
But if that’s the case, we’ll be fine. I mean, it’s a lot of inter-point on these things.
DeForest Hinman
Okay, thank you for taking my questions.
David Gandossi
Okay, DeForest.
Operator
Your next question comes from Dan Jacome with Sidothi & Company. Go ahead, please, your line is open.
Dan Jacome
Yes, good morning. And most of my questions have been answered.
I was just wondering first on all the new capacity NBSK coming online, I think that’s been well telegraphed by right now. I was just wondering if you can kind of break out with your line of sight how much is going to be absorbed by tissue machines and then what you’re saying for new or maybe refurbish paper machines?
And then my second question was regarding the overall very high level, of course, very high-level landscape for distressed assets, I thought that was an interesting part of your Analyst Day presentation about kind of – the history of your company, but then for future to that it will be an opportunity for you longer-term. That’s it, thanks a lot.
David Gandossi
Well, on the demand side on paper, yes, there is some growth in tissue consumption in pockets; Southeast Asia, Middle East relatively flattish in North America and the U.S. But growing net overall, maybe 1.5 million to 2 million tonnes a year on a net basis is kind of what we’re expecting going forward here in the near-term.
On the paper side, consumption is good. Paper consumption is pretty nicely correlated to global GDP, and there’s lots of good growth happening globally, so paper demand chugs along.
It’s a mixed bag. It’s pretty hard to quantify at all with all the different products.
But generally, as I was saying earlier, consumption of paper is pretty healthy at the moment. So I think it’s just –
Dan Jacome
Okay, and then the distress. Yes, it does.
I was just curious, where like, what’s this going to be, who is observing what. And then any commentary on the distress asset landscape or is that kind of still at the same tonne from Analyst Day?
David Gandossi
Are you talking paper assets or pulp assets? Or I’m just not –
Dan Jacome
Yes, so that’s kind of the question too is, where do you think the low-hanging fruit will be on – for distress asset? Would it be more on lumber side or pulp?
David Gandossi
I see what you’re getting at. So I think we’re –
Dan Jacome
For future M&A.
David Gandossi
Yes. What I’m trying to signal, or what I’ve been saying is, that we are poised for growth.
We got a good balance sheet. We’re generating good cash flow and we want to grow, but we are disciplined.
You don’t create shareholder value by buying an expensive asset at the peak of a cycle. And so the focus is really a parallel focus to see, optimize our organic growth.
And if you combine a new sawmill with Stendal that update to Friesau, and you start looking for some good needy pulp capacity expansions in our existing males, that’s big enough to move the dial. And we know it will be accretive because like I said, we can do all that stuff in a three-year payback or better.
That’s – we won’t do it if we don’t have a really good project. So we’re not going buy distressed pulp mill.
We’re not in the paper space right now, we’re not – I don’t think you’ll – I mean, there’s no such thing as a distressed sawmill right now unless it’s a tiny little thing that doesn’t make, I guess, lumber prices there so high. So it’s really the organic story, I think it’s the main message.
Dan Jacome
Right, okay, just want to clarify that, it’s hopeful. And then – so how much – have you broken out exactly how much wood chips you are transporting from you’re migrating from the lumber to your pulp mills just in terms of numbers?
Or all the wood chips created by the sawmill going directly to the pulp mills?
David Gandossi
Yes. So our pulp mills buy saw mill residual chips from a good number of saw mills in the regions where they operate.
Our Friesau mill supply is about 25% of Rosenthal’s fiber requirement today and we buy it from many others. Pulp mill needs many sawmills to feed it.
They’re very big compared to sawmills.
Dan Jacome
Right. You mean, like as if spread it out, they can’t – you don’t want it to be all be coming your own assets?
David Gandossi
Yes. Well, there is no sawmill big enough that could produce enough to feed the fiber for a pulp.
Dan Jacome
Yes. No, that’s good, 25% that’s what, what I was looking for.
All right, thank you.
David Gandossi
Okay, super.
Operator
There are no further telephone questions at this time. I’ll turn the call over to David Gandossi.
David Gandossi
Okay. Well, thanks, everyone, for joining the call.
Appreciate you listening in all the questions. As you know, Dave and I are always happy to take calls offline.
So if anybody has anything further they want to ask, don’t hesitate to give us a call. Thanks again.
Bye for now.
Operator
This concludes today’s conference call. You may now disconnect.