DBRS Downgrades Cascades Inc. to BB, Changes Trends to Stable

DBRS has today downgraded the Issuer Rating of Cascades Inc. (Cascades or the Company) to BB from BB (high) and has changed the trend to Stable from Negative. The downgrade reflects the increase in financial risks as a result of a continuing rise in debt levels and weaker-than-expected operating results. The Stable trend reflects DBRS’s anticipation of the Company stabilizing its financial profile to stay within the current rating range in the foreseeable future, with modest improvement in operating results in the last half of 2013 through 2014 supported by recent price increases, especially in containerboard, and benefits from restructuring initiatives. Pursuant to the “DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers” methodology, DBRS has confirmed the recovery rating of the Senior Unsecured Debt at RR4, indicating that the instrument rating would be the same as the Issuer Rating. Therefore, DBRS has also downgraded the rating of the Senior Unsecured Debt to BB from BB (high) and has changed the trend to Stable from Negative.

The Company’s operating results have been under pressure amid challenging market conditions, and its financial profile has been weak for the BB (high) rating. DBRS changed the trend on the ratings to Negative on September 28, 2012 (see press release of the same date for details), and stated at that time that a lack of progress in strengthening the Company’s financial profile may lead to a one-notch downgrade. Cascades did report stronger earnings in 2012, but the results were below DBRS’s expectations. Furthermore, the earnings recovery stalled in Q1 2013. The Company has also incurred deficits in net free cash flow due to high investments (capital expenditures, acquisitions, the Greenpac Mill LLC joint venture, etc.) in the same periods. The deficits were funded with debt, adding to the already high debt levels increasing the financial risks. Capital expenditures are expected to remain at an elevated level while the Company executes its modernization program in the next few years. A lack of meaningful free cash flow would limit deleveraging actions to remedy the condition in the near future. The increasing financial risk is no longer compatible with the BB (high) rating.

Market conditions are expected to remain mixed in the near term. Recent successes in pushing price increases, particularly in containerboard, are positive and better operating performance in the near term. However, the Company still faces a number of headwinds, particularly cost pressures. The decline in raw materials costs, notably in recycled fibre, appears to have ebbed. Energy cost may be on the rise, which further adds to cost pressures. Rising costs would partly erode the gains from price increases. The European economy continues to be depressed and weighs on Boxboard Europe results. Finally, the impact of the Canadian dollar is uncertain. Although the trend is beneficial at the moment, renewed strength in the Canadian dollar would pressure earnings again. Overall, DBRS expects the Company to report modestly better results in 2013 through 2014, but profitability is expected to remain below historical average levels.

The Company is committed to its modernization program and is making progress in executing its strategic action plan to improve its operations. In 2012, Cascades has rationalized its containerboard converting platform in Ontario, closing inefficient facilities and upgrading the remaining facilities to improve efficiency and productivity. Cascades also invested in a joint venture with third parties in building a state of the art recycled linerboard mill, Greenpac Mill LLC (Greenpac). Greenpac will confirm Cascades as one of the leaders in the containerboard industry. Cascades has also made a number of acquisitions to strengthen its market position in Containerboard (Bird Packaging Ltd. in 2012), Boxboard Europe (increased ownership in Reno de Medici S.p.A. (RdM) in 2011) and Tissue Papers (full ownership of Papersource Converting Mill Corp. (Papersource) in 2011). Benefits from these restructuring initiatives and modernization efforts should improve the Company’s competitiveness and would position it for a stronger recovery in earnings.

However, ongoing investments to upgrade the information systems and facilities will keep capital expenditures at current elevated levels. Although internal cash generation is expected to improve in line with earnings, DBRS anticipates that the Company is likely to break even in free cash flow in 2013, limiting deleveraging actions. The debt level will likely remain little changed and debt leverage will remain aggressive. Nevertheless, DBRS expects the Company to be able to meet all of its funding needs, and DBRS has no concerns about the Company’s liquidity. Moreover, a modest debt maturity schedule with no material debt repayment before 2016 would add to the Company’s financial flexibility. DBRS expects the Company’s financial profile to improve modestly in the next few years, but it is not likely to achieve its leverage target (the ratio of debt-to-EBITDA) of three times before 2016. The current ratings are expected to remain unchanged in the foreseeable future.

DBRS has updated its 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 between 30% and 60% for senior unsecured debtholders.

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 Companies in the Forest Products Industry, which can be found on our website under Methodologies.