DBRS Confirms Cascades Inc. Ratings at BB (high), Stable

DBRS has today confirmed the Issuer Rating and Senior Unsecured Debt rating of Cascades Inc. (Cascades or the Company), both at BB (high) with a Stable trend. The confirmation recognizes the Company’s acceptable, albeit weaker, financial metrics, which remain within the current rating parameters. The Stable trend reflects the Company’s solid liquidity and minimal long-term debt due until beyond 2016.

The Company’s recovery stalled in the last half of 2010 but 2010 results were still well above the lows experienced in 2008 and prior. However, the challenging industry conditions carried through to 2011 and the Company’s performance was below expectations in the first half of the year (H1 2011). EBITDA declined by 31% in H1 2011 over 2010, with the Specialty Product and Tissue segments taking the most severe hit, with their EBITDA levels declining by approximately 42% and 40%, respectively. A strong Canadian dollar and rising prices of recycled fibres largely contributed to the earnings decline.

Nevertheless, DBRS expects the Company’s financial profile to stabilize in the near term. This is based on the expectation that the announced increase in prices in all core products, except Containerboard, will have a positive impact on earnings for the rest of 2011. In addition, benefits from restructuring initiatives and an improvement in operating rates and efficiency should help boost earnings. Furthermore, the two negatives that have affected performance of late – recycled fibre prices and the Canadian dollar – seem to be fading. Recycled fibre prices appear to have peaked and the Canadian dollar is back to below parity with the U.S. dollar. These developments bode well for the Company’s performance.

The Company has continued to deleverage during H1 2011. Cascades received a substantial amount of cash proceeds ($335 million net of taxes), largely from the sale of converting business Dopaco Inc., which it used to reduce debt. Furthermore, the Company continues to enjoy solid liquidity, with cash and available committed facilities totalling $622 million at the end of June 2011. The Company has modest debt due in 2012 and minimal refinancing risk until beyond 2016, which adds to its financial flexibility

The current rating continues to be supported by the Company’s solid business profile. Reducing business risk are Cascades’ value-added packaging, its 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). In addition, contributions from the sizeable, higher-margin and comparatively less volatile tissue business further enhance earnings stability.

However, DBRS notes that the current debt-to-capital structure is still aggressive for a cyclical company, even when excluding the portion of non-recourse debt on the balance sheet (approximately 10% of total). The Company’s debt coverage ratios are at the low end of the current rating range, and a lack of progress in strengthening its financial profile in the next 12 months would likely 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 forecast 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 debtholders.

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

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