Executive Summary / Key Takeaways

• Mercer International operates a diversified portfolio across cyclical pulp and solid wood markets, strategically balancing its core NBSK pulp business with growth initiatives in mass timber and green chemicals like lignin.
• Despite recent market volatility and operational challenges, the company demonstrated improved financial performance in Q4 2024 and is targeting $100 million in operational efficiency and cost savings by the end of 2026 to enhance resilience.
• Mercer possesses key technological differentiators, including biomass cogeneration for cost-efficient green energy and a pilot lignin extraction plant, positioning it for growth in the circular carbon economy.
• The outlook for 2025 is mixed, with expectations for stable to modestly increasing softwood pulp prices in North America and Europe, but continued weakness in hardwood pulp and solid wood markets (lumber, pallets) due to economic uncertainty and high interest rates, particularly impacting mass timber project timelines.
• Potential U.S. tariffs and trade policy developments pose a significant risk, but management is actively developing mitigation strategies and sees opportunities to redirect product flows to capitalize on shifting competitive dynamics.

A Forest of Opportunity: Balancing Tradition with Transformation

Mercer International Inc. stands at a fascinating intersection of traditional forest products and emerging green industries. Rooted in the cyclical world of pulp and lumber, the company has strategically evolved, notably through acquisitions that built its Solid Wood segment encompassing sawmills and mass timber facilities. This diversification, evident in financial data showing increased goodwill and debt around the time German sawmills and North American mass timber assets were aggregated, was a deliberate move to balance the portfolio beyond its core pulp operations. The dissolution of the Cariboo Pulp & Paper joint venture in Q1 2024 and the ongoing effort to sell the sandalwood business (Santanol) further refine this strategic focus.

The company's overarching strategy is clear: maximize operational efficiency, generate cash flow, and reduce debt, while simultaneously investing in growth areas aligned with the circular carbon economy. This approach is a direct response to the inherent volatility of commodity markets and external pressures like high interest rates and potential trade barriers.

Mercer's competitive landscape is populated by larger, more diversified players like International Paper (IP) and West Fraser Timber (WFG), as well as more focused competitors such as Canfor (CFP) in lumber and pulp, and Rayonier Advanced Materials (RYAM) in pulp and specialty cellulose. While Mercer may lack the sheer scale of IP or the vertical integration of WFG, it carves out its position through operational efficiency in its core assets and a strategic pivot towards differentiated, low-carbon products.

A key differentiator for Mercer lies in its technological capabilities, particularly in green energy. The company's biomass cogeneration facilities, which utilize byproducts like black liquor and wood waste, provide a tangible competitive edge by achieving 10-15% lower energy costs per unit compared to relying solely on fossil fuels. This translates directly into improved gross margins and enhanced resilience, especially in energy-intensive pulp production. Furthermore, Mercer is actively investing in the future with its new lignin extraction pilot plant at the Rosenthal mill. This initiative aims to develop lignin as a sustainable alternative to fossil fuel-based products like adhesives and battery components. While still in the development phase, management believes this could form the foundation of a profitable new business segment, aligning perfectly with the strategy to expand into green chemicals and add shareholder value on the existing asset base. The company is also exploring a potential carbon capture project at its Peace River Mill, signaling a commitment to further reduce its carbon footprint and potentially improve mill economics. For investors, these technological advancements represent a crucial part of Mercer's long-term moat, offering potential for higher margins, new revenue streams, and a stronger market position in an increasingly carbon-conscious world.

Performance Under Pressure: Navigating Market Cycles

Mercer's financial performance over the past year reflects the challenging, yet improving, market dynamics. Full year 2024 saw a significant increase in Operating EBITDA to $243.7 million (net loss of $85.1 million) compared to $17.5 million (net loss of $242.1 million) in 2023, driven by stronger pulp markets, lower production costs, and cost reduction initiatives.

The first quarter of 2025, however, presented a mixed picture compared to the prior year period. Total revenues decreased by approximately 8% to $507.0 million from $553.4 million in Q1 2024. This was primarily due to lower pulp sales volumes, partially offset by higher pulp and lumber sales realizations. Costs and expenses decreased by about 10%, benefiting from lower pulp volumes and the positive impact of a stronger U.S. dollar on foreign currency denominated costs, though partially offset by higher planned maintenance downtime and increased per unit fiber costs. Operating income improved to $6.7 million in Q1 2025 from a loss of $0.4 million in Q1 2024, partly due to the absence of the non-cash loss on the dissolution of the CPP joint venture recognized in Q1 2024.

Looking at the segments in Q1 2025:

• Pulp Segment: Revenues decreased by approximately 12% to $381.1 million from $432.4 million in Q1 2024. Segment Operating EBITDA decreased by about 27% to $49.9 million from $68.5 million. This decline was primarily attributed to higher planned maintenance downtime (22 days at Celgar vs. none in Q1 2024, impacting EBITDA by an estimated $29.5 million), partially offset by higher pulp sales realizations and favorable foreign exchange impacts. Pulp production decreased by 15% year-over-year, mainly due to the CPP dissolution and Celgar downtime, though production modestly increased from Q4 2024 after adjusting for downtime. Average NBSK sales realizations increased across key markets in Q1 2025 compared to Q1 2024, while NBHK realizations decreased due to lower net prices in China.
• Solid Wood Segment: Revenues modestly increased to $122.7 million from $119.0 million in Q1 2024, driven by higher lumber and manufactured products revenues, despite lower revenues from other products like pallets and biofuels. Segment Operating EBITDA remained negative at $0.3 million compared to negative $0.9 million in Q1 2024. Higher lumber sales realizations partially offset increased per unit fiber costs, which rose about 12% year-over-year due to strong demand in Germany. Lumber production was relatively flat, but sales volumes increased by 8%. Manufactured products revenues increased by 13%, primarily due to the timing of mass timber projects. Pallet revenues decreased by 17% due to lower sales volumes reflecting weak European economic conditions.

Liquidity remains adequate, with $181.5 million in cash and equivalents and $289.2 million available under revolving credit facilities as of March 31, 2025, totaling $470.7 million in aggregate liquidity. Cash used in operating activities in Q1 2025 ($3.0 million) was significantly lower than in Q1 2024 ($29.2 million), reflecting changes in working capital, including increases in receivables and inventories offset by increases in accounts payable. Capital expenditures were $20.1 million in Q1 2025, focused on strategic projects and maintenance.

Strategic Momentum and Forward Vision

Mercer is not standing still. A company-wide program targeting $100 million in operational efficiency and cost savings by the end of 2026 is well underway, with management confident in achieving this goal. This initiative, alongside targeted reductions of $20 million in inventories and $20 million in CapEx for 2025, underscores the focus on enhancing profitability and cash generation.

Key capital projects are progressing. The Celgar woodroom upgrade, completed in Q1 2025, is designed to reduce fiber costs and dependence on sawmill residuals. The Torgau lumber expansion project aims to increase dimensional lumber volume by 40,000 cubic meters annually, reaching over 100,000 cubic meters in 2025, enhancing the value-added product mix and synergies. The Spokane sorting line project, expected to be completed by mid-2025, will enable sourcing lower-cost feedstock and producing higher-quality lamp stock, significantly reducing fiber costs at that facility.

The outlook for the coming quarters reflects a nuanced view of market dynamics and strategic positioning.

• Pulp: Management expects softwood pulp prices to modestly increase in Europe and North America in Q2 2025, supported by stable demand and ongoing supply constraints. However, lower prices are anticipated in China, particularly for NBHK, due to the weakened economic environment. Per unit fiber costs for German pulp mills are expected to be higher in Q2 2025 due to strong demand and reduced supply, while Canadian costs should remain relatively stable. The significant price gap between softwood and hardwood is expected to persist well into 2025, favoring Mercer's predominantly softwood portfolio. Planned maintenance downtime in Q2 2025 (21 days) will impact production and EBITDA, with further downtime scheduled in Q3 and Q4.
• Solid Wood: The outlook remains challenging due to weak European economic conditions and high interest rates. Lumber prices are expected to modestly decrease in the U.S. in Q2 2025 due to the economic environment, while European prices may slightly increase due to higher fiber costs. Pallet prices are expected to remain flat. Mass timber project timelines are being impacted by high interest rates, with some projects slipping into 2026. Management anticipates a weaker Q2 and Q3 2025 for mass timber, with improvement starting in Q4 and potentially ramping up a facility to two shifts in early 2026. Despite near-term headwinds, the long-term fundamentals for lumber (low inventories, curtailments, housing stock) and mass timber (environmental/economic benefits, growing popularity) are seen as strong, with significant pent-up demand awaiting lower interest rates. Mercer is well-positioned in mass timber with substantial capacity (around 30-35% of North American capacity), a broad product range, and a strategic geographic footprint.

Potential U.S. tariffs on Canadian and European wood products and related countermeasures represent a significant external risk. Management is closely monitoring developments and has contingency plans, including redirecting products to other geographies. They note that tariffs could impact wood costs for Canadian mills and that the competitive dynamics could shift, potentially favoring European lumber into the U.S. if Canadian anti-dumping duties increase significantly. Mercer's diversified manufacturing locations and product offerings (e.g., sourcing U.S. wood for Spokane, dedicating Canadian assets to the Canadian market, leveraging Friesau's cost structure) provide flexibility to mitigate some of these impacts.

Debt reduction remains a priority, building on the $100 million reduction achieved through the 2026 senior note refinancing in late 2024. Management believes cash flow from operations, cash on hand, and available credit facilities will be sufficient to cover capital requirements and dividends for the next 12 months, while continuing to seek opportunistic debt reduction.

Risks and Considerations

Investing in Mercer involves exposure to several key risks. The highly cyclical nature of pulp and lumber markets means prices and demand can fluctuate significantly based on global macroeconomic conditions, industry capacity, and foreign exchange rates. Raw material costs, particularly fiber, are volatile and represent a significant operating expense. Inflation and rising interest rates can pressure margins and dampen demand, especially in the construction-dependent solid wood segment. Geopolitical conflicts and changes in international trade policies, including the potential imposition of tariffs, could disrupt supply chains, alter competitive dynamics, and negatively impact financial results. Operational risks include potential unplanned downtime at mills, which can significantly reduce production and profitability, as seen in Q3 2024. Regulatory and environmental compliance costs are ongoing considerations. While management has mitigation strategies and sees long-term potential in green products, the timeline for mass timber market recovery is dependent on external economic factors, and the commercial success of new initiatives like lignin is not yet proven.

Conclusion

Mercer International is a company actively transforming itself within the confines of cyclical commodity markets. While the core pulp business provides a foundation, currently benefiting from favorable softwood supply dynamics despite recent operational noise, the strategic emphasis is clearly shifting towards enhancing efficiency and growing the solid wood segment, particularly mass timber, and exploring new green chemical opportunities like lignin. The company's technological edge in green energy provides a tangible cost advantage, and its investments in mill upgrades and new product development are aimed at long-term value creation and diversification away from pure commodity exposure. Near-term headwinds persist, notably weak demand in European solid wood markets, the impact of high interest rates on construction and mass timber project timelines, and the uncertainty surrounding potential tariffs. However, management's proactive approach to cost reduction, operational reliability, debt management, and strategic positioning across geographies demonstrates a clear path forward. For investors, the thesis hinges on Mercer's ability to successfully execute its efficiency program, capitalize on the expected long-term growth in mass timber and green products, and navigate the volatile commodity cycles and external risks, ultimately translating its strategic initiatives and technological advantages into sustained profitability and shareholder value. The coming quarters will be critical in demonstrating progress on cost savings and navigating the uncertain trade policy landscape.