DBRS Confirms TimberWest at BBB

DBRS has today confirmed the Senior Unsecured Debentures rating of TimberWest Forest Corp. (TWF or the Company) at BBB. The trend is Stable. DBRS has also removed TWF from Under Review with Developing Implications, where it was placed on December 15, 2008. The confirmation reflects TWF’s low financial and business risk resulting from its recent refinancing, which will enable the Company to endure a moderate period of weak market conditions and poor financial performance. TWF has successfully completed its previously announced issue of $150 million of convertible secured and unsecured debentures and has also replaced its Tranche A and Tranche B term loans with a new credit facility that will provide the Company with what DBRS believes is sufficient flexibility to operate through the current market downturn.

DBRS considers the announced financing and credit facility amendments to be a positive development. The refinancing removes the challenge of near-term debt maturities, with the convertible debentures maturing in 2014 and the new credit facility maturing in 2012. TimberWest also obtained unitholder approval on December 19, 2008, for a modification to the Series A subordinate note component of the Company’s stapled units, which will move to a variable rate of 2% to 12% in lieu of the previous 12% fixed rate. TWF is allowed to defer distributions for a period of 18 months and also has the option of paying the distributions in the form of cash or shareholder units. The Company has announced it will defer the January 2009 distribution and subsequent distributions until market conditions improve.

The rapid deterioration in U.S. residential housing market conditions is largely responsible for the sharp drop in demand for logs and in pricing, which are the key drivers of the Company’s earnings and cash flows. More than half of the Company’s sales revenues are generated from North American sawlog and pulp log markets, and the continuing deterioration in construction activity and increasingly oversupplied global pulp markets does not bode well for medium-term earnings and cash flow generation. The North American building products sector is close to the bottom of the cycle, but a meaningful improvement is unlikely to occur until 2010 or 2011. In the interim, ongoing weakness in the U.S. housing market and sawmill curtailments in western Canada and the U.S. Pacific Northwest are expected to keep sawlog demand and prices at unusually low levels for the next 12 to 24 months. In addition, reduced global economic activity has lowered demand for paper and packaging products and the associated raw material, market pulp. Rapidly rising pulp inventories have had a negative impact on pulp prices, a condition that is expected to be maintained into 2009, with an associated negative effect on the demand and pricing for pulp logs. As a result, TimberWest’s log production and associated log sales are forecast to remain weak through 2009 and possibly 2010, and the Company’s earnings and cash flows will remain under pressure during that time.

Despite a pessimistic near-term market outlook, TWF is well positioned to weather a period of weak market conditions. The balance sheet is moderately leveraged (debt imbedded in the stapled units is considered to be equity), and the deferment of unitholder distributions will ensure negative cash flow is minimized in the near term. Cash of $31 million at December 31, 2008, and undrawn amounts under the new credit facility amount to approximately $130 million, more than sufficient cash to enable TWF to survive extended trough conditions in global building products markets. Annual capex is expected to be less than $5 million, a factor that will positively affect free cash flow. In addition, the Company has the option of paying the distributions in the form of shareholder units, which provides additional financial flexibility. DBRS expects the Company’s financial performance to stabilize close to 2008 levels. Failure to stabilize financial performance could lead to negative rating actions.

While the collapse of the U.S. housing market has brought timber and lumber prices to trough levels in the past nine months, the longer-term outlook is optimistic. Significant reductions in global log availability should lead to increased sawlog prices in future years. The implementation of Russian log export taxes, which commenced in 2007 and are expected to increase substantially in late 2009, will significantly reduce Russian log exports to Japan and other Asian countries in 2010 and subsequent years. In addition, ongoing log supply restrictions in Ontario and Québec and anticipated harvest curtailments as a result of the mountain pine beetle epidemic in the interior of British Columbia will also tighten log demand-supply ratios. Demand could outstrip supply as the peak of the next building products cycle approaches, producing record high prices for sawlogs. TWF has the potential to significantly increase earnings and cash flows in the next housing market upturn.

TWF owns 796,000 acres of forest lands that have an estimated market value of US$1.5 billion. A portion of the forest lands on Vancouver Island has been classified as higher and better use (HBU) properties with a market value in excess of $300 million. TWF’s recognized HBU lands are expected to benefit from the regions’ high desirability, limited land availability and changing demographics in future years, augmenting cash flows. The Company has reclassified its HBU land portfolio into core and non-core lands. Core lands (80,000 acres) require further development, including planning and zoning changes to maximize market value, and are unlikely to translate into increased sales until 2010. Non-core lands (54,000 acres) have reached maximum value and will be sold as is in the near term. Timberlands and HBU properties are easily saleable, and the Company’s asset value-to-debt coverage ratio of five times provides a high level of liquidity and a financial risk that is substantially less than forest products industry averages.

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating the Forest Products Industry, which can be found on our website under Methodologies.

This is a Corporate rating.