DBRS Assigns Issuer Rating and Confirms Cascades Inc. at BB (high)

DBRS has today assigned Cascades Inc. (Cascades or the Company) an Issuer Rating of BB (high) and has confirmed its Senior Unsecured Debt at BB (high). The trend has been changed to Negative. Pursuant to DBRS’s Leveraged Finance rating methodology, a recovery rating of RR4 (30% to 50% recovery) has been assigned to the Company’s Senior Unsecured Debt, which corresponds to the BB (high) rating.

The Company’s value-added packaging, specialty product sales mix and high containerboard converting integration levels (a strategy that has improved earnings stability through industry cycles relative to producers with a larger proportion of commodity products and limited integration) reduces business risk. In addition, a large and comparatively stable earnings contribution from Cascades’ tissue business provides a counterbalance to the commodity products businesses, further enhancing the Company’s business profile. However, leverage is high for a company with cyclical product lines, and debt and cash flow coverage ratios are expected to remain weak in 2009, keeping financial risk at high levels. The change to a Negative trend reflects the fact that the Company’s credit profile is weak for the current rating. In addition, near-term market conditions do remain challenging. A slower-than-expected U.S. economy, a reversal in recent Canadian dollar weakness, and the chance that industry supply management efforts may not be sufficient to stabilize paper prices could put more pressure on the Company’s operating performance. In the event that Cascades cannot stabilize its financial performance and credit metrics continue to deteriorate from current levels, the current rating would be at risk.

Despite the Company’s positive business aspects, its current credit metrics reflect challenging industry conditions. Product price increases were obtained in each of the Company’s business segments in 2008. However, rising raw material costs (primarily recycled fibre and commercial pulp), high energy and energy-related prices, and strength in the Canadian dollar offset most of the benefits of higher product prices in the first half of 2008. In the near term, the earnings and cash flow outlook is neutral, as widespread supply management tactics are expected to limit recent commodity containerboard product price erosion. Average annual containerboard prices in 2009 are expected to be close to the average attained in 2008. Tissue and specialty packaging product prices are expected to stabilize in 2009. Although weaker market conditions will lead to lower sales volumes in 2009, stable average annual product prices and reduced operating costs are expected to translate into earnings and cash flows that are close to levels seen in previous years. Profit initiatives, including the closure of uncompetitive mills/machines and non-core asset divestitures, are also expected to benefit earnings.

Coincident with relatively stable earnings and cash flows, debt levels and credit metrics are not expected to substantially change from levels recorded in the last twelve months. Capex is expected to be $100 million substantially less than depreciation in 2009 and cash flow from operations should be more than sufficient to fund capital expenditures next year. Although free cash flow is expected to be positive, it is unlikely to be sufficient to produce a major improvement in the financial profile. As a result, leverage is forecasted to remain high. There are no significant debt repayments in the next two years, which provides the Company with the flexibility to focus on operating cash requirements. Cascades had cash and available credit facilities of approximately $300 million at December 31, 2008. Hence short-term liquidity is not a problem. Cascades has evolved into a strong industry player through a series of successfully integrated acquisitions. Despite challenging industry conditions, the Company has generated positive earnings and funded operations internally, in contrast to the large net losses and free cash flow deficits experienced by many of its paper industry peers. As a result, the Company is well positioned to grow earnings and cash flows when industry conditions improve.

DBRS has simulated a default scenario for Cascades in order to analyze the potential recovery for the Company’s senior unsecured debt in the event of default. The scenario assumes a prolonged period of severe economic conditions, regardless of how hypothetical or unlikely the conditions may be, in which product demand and prices plummet. EBITDA quickly declines and turns negative over the forecasted period. DBRS assumes that the Company would be reorganized as a going concern in the event of default, and has derived a recovery rating of RR4 for the senior unsecured debt. RR4 corresponds to recovery prospects of between 30% and 50% for senior unsecured debtholders.

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

The applicable methodologies are Rating the Forest Products Industry and Rating Leveraged Finance, which can be found on our website under Methodologies.

This is a Corporate rating.