Billionaire Loads up on Pulp Stock: Mercer International (MERC)

Billionaire Peter Kellogg keeps buying more and more shares of Mercer Internatioal (MERC). Most investors are unfamiliar with Mercer International Inc., which manufactures and sells pulp produced from wood chips and pulp logs. The company offers northern bleached softwood kraft (NBSK) pulp and market pulp.

Similarly, most investors have never heard of Peter Kellogg even though he is one of the world's richest people and widely regarded as a shrewd value investor.

Kellogg has been accumulating shares of MERC in recent weeks. He now has 15.3 million shares. His last reported purchase was on Nov. 14, 2011 where he added another 100,000 shares at $5.77.

This raises the question of what Mr. Kellogg sees in an old cyclical company like MERC.

First of all, shares of MERC have been battered in recent months. In the summer, shares of MERC traded for $14, yet they have plummeted to $5.80.

MERC is a value stock on a number of metrics. First of all it trades for 3 times cash flow and has a trailing P/E of 2.83. The company does have over $1 billion of debt and a market cap of $325 million.

The bullish case is that there will be a supply/demand imbalance over the coming years. There is little supply of pulp coming on stream over the next few years. Adding supply of pulp is similar to adding supply of any raw material like iron ore. It takes five to seven years to add capacity, and there are few shuttered mills that can be re-started.

The question is whether NSBK pulp prices will remain depressed over the next few years. Production is about 23 million tons per year, but what is interesting is that 5.3 million tons of capacity have been taken off stream over the last three to four years.

If prices of NSBK do not crater in the next recession, MERC could offer value investors a decent prospect of return.