DBRS Changes Trend to Negative on West Fraser BBB (low) Rating

DBRS has today changed the trend to Negative from Stable on the BBB (low) rating of the Unsecured Debentures of West Fraser Timber Co. Ltd. (West Fraser or the Company). The trend change reflects the continued deterioration of credit metrics and the fact that market conditions are weaker than expected and could take longer than anticipated to recover. The Company also faces the risk that a reversal in recent Canadian-dollar weakness and the chance that industry supply management efforts may not be sufficient to stabilize product prices would put more pressure on the Company’s operating performance. In the event that West Fraser can not stabilize its financial performance and credit metrics continue to deteriorate from current levels, the current rating would be at risk.

West Fraser performed to expectations in 2008 and corporate earnings in 2009 are forecast to remain close to 2008 levels despite weak market conditions. The Company is expected to report weaker earnings and cash flows in H1 2009 before recovering in H2 2009. Demand for market pulp declined in 2008 due to decreasing graphic paper demand in the second half of the year in the United States, Europe and Asia, resulting from the slowdown in the global economy. Global market pulp producers have taken substantial downtime in late 2008 and early 2009 to bring supply in line with demand. These global market pulp production curtailments are expected to take until H2 2009 to have a positive effect on prices as customers work down high inventories. In the interim, low sales volumes and low transaction prices will have a negative impact on earnings and cash flows. The risk lies in the possibility that further economic contraction will result in additional reductions in print advertising that would require extended production curtailments and result in an indeterminable delay in a price recovery in all types and grades of market pulp.

Recessionary forces are expected to reduce packaging demand in Europe and North America over the next 12 months. However, aggressive industry production curtailments are expected to bring supply in line with lower demand, enabling linerboard producers to support average annual product prices at levels slightly lower than achieved in 2008. Lower energy, chemical and freight costs and a weak Canadian dollar should enable West Fraser to partially offset the negative impact of lower sales volumes in 2009.

The rapid deterioration in U.S. residential housing market conditions is largely responsible for the sharp drop in demand for building products and in pricing, which are key drivers for the Company’s earnings and cash flows. The North American building products sector is close to the bottom of the cycle, but a meaningful improvement is unlikely to occur until 2010. 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 building products segment earnings and cash flows at low levels. However, evidence of a recovery in 2010 is expected to have a positive influence on prices in H2 2009.

A lower Canadian dollar (year-to-date average is about 15% less than the average for 2008) and reduced energy, chemical and transportation costs will will have a positive effect on operating costs in all product lines, enabling the Company to keep 2009 earnings close to 2008 levels.

The Company’s balance sheet remains moderately leveraged (debt as a percentage of capital is less than 30%) and its liquidity position is favourable (cash on hand and availability credit facilities were $566 million at the end of 2008), which should be more than enough to pay debt maturities of $150 million in October 2009 and $100 million in March 2010, as well as fund its operating needs through the current downturn. Capex is forecast to be substantially below depreciation in 2009, a strategy that will have a positively effect on cash generation. The Company is committed to stemming cash outflows by curtailing production when operating costs fall below break-even levels, a strategy that will conserve cash until market conditions rebound. Furthermore, West Fraser is a low-cost producer and should generate favourable profitability once the building products market turns around.

Note:
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.