DBRS Confirms TimberWest Issuer Rating at BBB

DBRS has today confirmed the Issuer Rating of TimberWest Forest Corp. (TWF or the Company) at BBB; the trend remains Stable. The rating action recognizes the significant financial flexibility afforded the Company by it large timberland holdings which can be easily monetized. In addition, the confirmation recognizes that actions taken by the Company to improve its returns and cash flow generation are starting to bear fruit. The Company has showed modest improvement in its operating results despite still difficult U.S. market conditions impacted by the weak housing market.

The key support to the Company’s current rating continues to be its large holding of timberlands. Although operating performance at the Company has stabilized and has even started to show a modest improvement in 2010, its credit metrics remain well below the current rating range. TWF owns 787,000 acres of private forest lands with an estimated market value well in excess of three times the Company’s gross debt (excluding the subordinated notes which DBRS treated as equity) of $266.8 million, at face value ($354.6 million at fair value) at the end of 2010. These timberland assets can easily be monetized to raise funds, even in depressed markets, providing security to the debt holders.

The Company has returned to the long run sustainable annual harvest volume level (about 1.8 million cubic metres) in 2010 due to stronger demand from Asia, especially China, reversing its “deferred harvest strategy” deployed in 2009. The Company has also taken actions to improve profitability and preserve liquidity. TWF has lowered logging contractor rates and reduced overhead. However, profitability was constrained by a low average sales realization due to an unfavourable sales mix. Increased volume of lower value hemlock in the sales mix limited the improvement in average price to around $73 per cubic metre in 2010 from $70 per cubic metre in 2009 but well below prices of above $90 per cubic metre prior to 2008. The Company has reported positive EBITDA in 2010 compared to losses in the last two years even though market conditions remained weak.

TWF has lowered the distribution rate on the Stabled Units and deferred distributions. Stronger earnings and lowered cash distributions allowed TWF to generate free cash flow before working capital for 2010, a reversal from the last two years. The Company has also taken actions in 2010 to strengthen its capital structure. In the second quarter of 2010, the Company raised $60 million issuing stapled units and has paid down $59.6 million in bank borrowing, holding gross leverage (gross debt-to-total capitalization) near the 35% range, an acceptable level. The Company had over $102 million in available liquidity (cash and unused credit facility) at the end of 2010, ample liquidity to weather the current weak market conditions. Moreover, the Company has real estate (higher and better use land, HBU) with a market value in the range of $140 million to $160 million. In the near term, the non-core lands could be sold to augment cash flow and ensure that the Company is in compliance with its credit facility covenants.

Log demand is expected to show modest improvement in 2011. Ongoing weakness in the U.S. housing market and sawmill curtailments in western Canada and the U.S. Pacific Northwest are expected to dampen sawlog demand and prices until 2012, when DBRS believes a meaningful recovery in construction activities will start. However, rising demand from Asia, especially China, is expected to continue to grow and partly offset the weak U.S. market. DBRS expects the Company’s operating performance to show modest improvement in 2011. While the collapse of the U.S. housing market has brought timber and lumber prices to trough levels, the medium- and longer-term outlook is optimistic. Significant reductions in global log availability should lead to increased sawlog prices in future years. Further decline in supply from Russia due to escalating log export taxes will cause China and other Asian countries to turn to North America for logs, a positive development. 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 is approached, producing record high prices for sawlogs. TWF has the potential to significantly increase earnings and cash flows in the next housing market upturn.

DBRS expects the Company to generate positive free cash flow in 2011 and to strengthen it financial profile modestly in the near term. However, any meaningful increase in free cash flow deficit could lead to negative rating actions.

Notes:
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.