DBRS Confirms West Fraser Timber Co. Ltd. at BB (high), Trend Now Positive

DBRS has today confirmed the Issuer Rating and Secured Debentures rating of West Fraser Timber Co. Ltd. (West Fraser or the Company) at BB (high), with a trend change to Positive from Stable. This Positive trend reflects that West Fraser’s credit metrics are solid for the current ratings and are expected to remain sustainable going forward, driven by DBRS’s view on the sustainable improvement of the U.S. housing industry. Furthermore, West Fraser’s above-average business profile, low debt financial profile and its ability to generate free cash flow during times of weak operating performances also help support the Company’s credit ratings.

Market conditions in the first nine months of 2012 have strengthened, with higher lumber and panel prices driven by a steady improvement in the U.S. housing industry, indicated by SAAR (Seasonally Adjusted Annual Rate) housing starts of 872,000 in September 2012, the highest number since 2009. As a result, lumber and panel businesses have reported stronger results, which have more than offset weaker pulp results driven by lower pulp prices. Moreover, results for the first nine months were affected by a higher than normal utility-grade lumber sales component in Q1 2012, the result of a utility-grade lumber inventory buildup in the fourth quarter of 2011. This caused pressure on the low-grade lumber prices and is not expected to be repeated. Additionally, inventory levels in the lumber and panel industry supply chain are tight, and therefore any increase in demand would have positive effects on prices. All things considered, lumber and panel results going forward are expected to be strong, due to continuing improvement in the U.S. housing industry. Furthermore, pulp results are expected to stabilize at the current level, driven by stabilized demand from China, pulp prices and world pulp inventory levels. Altogether, DBRS expects West Fraser to generate stronger operating results in 2013, driven mainly by stronger lumber and panel results, while pulp results remain stable.

West Fraser’s business profile is above-average, compared with industry peers. It is the largest lumber producer in North America, with strong exposure to the West Coast and southern United States, and is also one of the industry’s lowest-cost producers. The Company has a solid position in pulp, which provides a degree of business diversity, and has recently stepped up its investment program to modernize its operating assets. West Fraser is well-positioned to benefit from the current improvement of the U.S. housing industry.

Moreover, over the past few years, West Fraser has been actively paying down debt with free cash flow and reducing risk in its financial profile. The ratio of gross debt-to-total capitalization has declined to about 18% at the end of September 2011 from 26% in 2007, and has remained at this level to September 2012. West Fraser has consistently demonstrated its ability to generate free cash flow (before working capital), even during times of weak operating performances – notably, in 2008 and 2009.

However, West Fraser could face a couple of wildcards: (1) the looming uncertainty of the U.S. government “fiscal cliff,” which could slow down the improvement of the housing industry in the United States; (2) unexpected and significant rises in sawlog costs; and (3) a stronger Canadian dollar, which can put pressure on the Company’s operating margin.

In conclusion, if the improvement in the U.S. housing industry proves to be sustainable going forward, and West Fraser’s credit metrics continue to demonstrate this sustainability, its credit ratings are likely to be upgraded by one notch during 2013.

DBRS has simulated a default scenario for West Fraser in order to analyze the potential recovery of its secured debt in the event of default. This 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. In this scenario, EBITDA quickly declines and turns negative over the forecasted period. DBRS assumes that in such an event of default, the Company would be reorganized as a going concern, and has thus derived recovery prospects of between 50% and 70%, corresponding to a recovery rating of RR3 for the secured debt.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating the Forest Products Industry (June 2011), which can be found on our website under Methodologies.