DBRS Confirms Cascades Inc. at BB (high), Changes Trend to Stable

DBRS has today confirmed the Issuer Rating and the Senior Unsecured Debt rating of Cascades Inc. (Cascades or the Company), both at BB (high). The trend has been changed to Stable from Negative, recognizing that the Company has stabilized its financial profile through a severe recession in the North American economy. With the North American economy on the mend, albeit at a weak pace, DBRS expects Cascades’ financial profile to remain near current levels in the medium term. Additionally, the current rating continues to be supported by the Company’s solid business profile with a leading market position in a number of its businesses.

The Company’s operating results were weighed down by deteriorating market conditions in 2008. The ratings were placed on a Negative trend in March 2009 to reflect DBRS’s concerns at that time about the Company’s aggressive leverage and the potential impact of a severe recession on its already weak financial profile. The Company has done a good job in managing its operations during the recession. A combination of lower material and energy costs, benefits from cost improvement initiatives and a weaker Canadian dollar have more than offset the decline in volume and prices. The Company has reversed the declining trend and reported a marked improvement in its operating results from the weak levels prior to 2009. DBRS believes that the low point of this cycle is behind the industry and market conditions are likely to continue to improve, albeit modestly, in the near- to medium-term. Moreover, the narrowing of the spread between selling prices and raw material costs, which weighed on H1 2010 results, appears to have reversed. Hence, DBRS expects the Company’s operating performance to improve for the remainder of the year. The Company’s financial profile is expected to remain compatible with the rating, albeit slightly weaker than 2009. Furthermore, DBRS expects the Company to report stronger results in 2011 in line with an anticipated uptrend in the general economy. In 2009, Cascades strengthened its balance sheet using free cash flow to pay down debt, and all debt coverage metrics also showed improvement.

The current rating continues to be underpinned by the Company’s solid business profile. Cascades’ 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, contributions from a sizeable, higher margin and comparatively less volatile tissue business further enhance earnings stability. In addition to the improved debt coverage ratios, the Company continues to have good liquidity with cash and available liquidity totalling $422 million at the end of June 2010. In addition, the Company has a modest debt maturity schedule which adds to its financial flexibility.

DBRS expects the Company’s financial profile to remain relatively stable in the medium term. On March 11, 2010, the Company announced a share repurchase program to buy up to 4.85 million shares, and Cascades spent $2.2 million in Q2 2010 (about $4 million in 2009) buying back shares. However, DBRS expects the Company to remain committed to strengthening its balance sheet and to be judicious in its share repurchases. The Company’s rating is expected to remain at the current level in the medium term. Despite the improvement, the Company’s leverage is still aggressive for a cyclical company and Cascades is vulnerable to the state of the economy. An unexpected sharp decline in the economy would place the Company at risk again and could lead to negative rating actions.

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, and 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. The RR4 rating corresponds to recovery prospects of between 30% and 50% for senior unsecured debt holders.

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

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