DBRS Confirms West Fraser Timber Co. Ltd. at BBB (low) with Stable Trends

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Unsecured Debentures rating of West Fraser Timber Co. Ltd. (West Fraser or the Company) at BBB (low). The trends remain Stable. The confirmation reflects that while earnings have been declining in the last 12 months (LTM) ended June 2015, especially in H1 2015, the Company’s credit metrics, which were already well above the range for the current rating category, have remained stable. The current rating is well supported by the strength of the financial profile.

Earnings in the recent period were buffeted by weak markets in the Company’s two main operating divisions: Lumber and Pulp & Paper. While the Panels division performed well, this segment accounted for only 7% of EBITDA in 2014 (compared with 75% for Lumber and 18% for Pulp & Paper). West Fraser is slowly winding down its multi-year modernization/upgrade/energy generation expansion capital program; thus, capital expenditures (capex) are expected to decline somewhat in 2015 and 2016, with 2017 being the first full year of normalized capex. DBRS anticipates modest year-over-year (YOY) operating earnings weakness in F2015, but a healthy free cash flow surplus. DBRS expects the Company to use this excess cash for acquisitions of modest/manageable scale and continued share buybacks. Given West Fraser’s current balance-sheet strength, DBRS does not expect the Company to focus on debt reduction as a key spending priority.

The unsteady recovery in U.S. housing construction, exacerbated by severe winter weather, has led to weak market conditions for North American lumber. As a result, duties on Canadian lumber exports to the United States under the Softwood Lumber Agreement (SLA) were triggered in Q2 2015 and are continuing in Q3 2015 as a result of the low sales prices. The SLA is due to expire in October 2015 and, while no trade actions may be brought during a standstill period through October 2016, a renewal of the SLA would provide clarity regarding West Fraser’s operating environment going forward, although the terms of the agreement may change.

While EBITDA interest coverage (22.0 times (x)) weakened modestly in the most recent LTM period versus 2014, it remains significantly stronger than the range normally associated with the current rating category, as do West Fraser’s other key metrics. Debt-to-EBITDA improved to 0.8x as lower debt offset the impact of weaker earnings and debt in the capital structure improved materially by 300 basis points to 16.9%. The Company’s financial risk profile therefore remains superior for the current rating; however, as the recent operating results illustrate, West Fraser’s key markets are quite volatile in nature and, while there is generally some benefit over the long term from the lack of correlation between earnings from the Pulp & Paper segment and Lumber/Building Products, this relationship does not always hold in the short term as recent results illustrate. Thus, from a business risk perspective, the current rating appropriately reflects the important challenges West Fraser is currently facing. Given the substantial cushion in terms of the Company’s credit metrics, it would take an unusually severe and prolonged market downturn before a negative rating action would be considered.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Companies in the Forest Products Industry (June 2015), which can be found on our website under Methodologies.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.