DBRS Confirms Canfor Corporation at BB (high), Stable Trends

DBRS has today confirmed the Issuer Rating and Senior Notes rating of Canfor Corporation (Canfor or the Company) at BB (high), both with Stable trends. The confirmations reflect Canfor’s solid credit metrics, which DBRS views as sustainable and likely to improve, driven by improvement in the U.S. housing market, as well as the stabilization of the pulp market. Furthermore, Canfor’s above-average business profile and conservative financial profile continue to support its credit ratings.

Lumber market conditions have strengthened in 2012, with higher lumber prices driven by a steady improvement in the U.S. housing industry, indicated by annual housing starts of 780,000 units for 2012, a 28% increase from 2011 and the highest number since 2009. As a result, lumber businesses have reported stronger results, which have more than offset weaker pulp results driven by lower pulp prices. Additionally, inventory levels in the lumber industry supply chain are tight; therefore, any increase in demand would have direct positive effects on prices. DBRS expects 2013 lumber results to be better due to expected continuing improvement in the U.S. housing industry. Furthermore, pulp prices have bottomed and have remained stable; DBRS expects pulp results to remain stable at the current level, driven by stabilized Chinese demand, pulp prices and world pulp inventory levels. Therefore, DBRS expects Canfor to generate overall stronger operating results in 2013, driven mainly by stronger lumber results, while pulp results remain stable.

DBRS expects the current recovery in the U.S. housing industry to be sustainable, supported by increasing household formation, record-high housing affordability and rising housing prices.

Canfor’s business profile is above-average compared to industry peers. The Company is one of the largest lumber producers in North America and is also one of the industry’s lowest-cost producers. It also has a significant position in pulp, which provides a degree of business diversity. Canfor has been improving the efficiencies of both lumber and pulp operations with sizable capital expenditures, notably the $300 million strategic investment program that started in 2010; as a result, Canfor is well positioned to benefit from the current improvement of the U.S. housing industry.

On top of its above-average business profile, Canfor has continued to maintain a conservative financial profile, with adjusted debt leverage (including operating leases as debt) below 26% since 2009. DBRS expects Canfor to continue to maintain a conservative financial profile. However, Canfor could face wild cards, including (1) unexpected slowdown in the recovery of the U.S. housing industry; (2) unexpected and significant rises in sawlog costs; and (3) a stronger Canadian dollar, which could put pressure on Canfor’s operating margin.

In conclusion, DBRS expects the recovery in the U.S. housing industry to be sustainable going forward. As a result, DBRS expects Canfor’s solid credit metrics to continue at current or even stronger levels. However, Canfor’s earnings history has been highly volatile in the past, which limits positive rating action at this time. If Canfor can demonstrate earnings stability for an extended period, it may lead to positive rating action.

DBRS has simulated a default scenario for Canfor in order to analyze the potential recovery of the Company’s senior 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. Based on the recovery analysis, DBRS believes that holders of the Senior Notes would recover approximately 60% to 80% of the principal; therefore, the recovery rating remains at RR3.

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 methodologies are Rating Companies in the Forest Products Industry and DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on our website under Methodologies.