DBRS Confirms Domtar Corporation at BBB (low) with Stable Trends

DBRS Limited (DBRS) has today confirmed Domtar’s (Domtar or the Company) Issuer Rating and Unsecured Debentures ratings at BBB (low), with Stable trends. The confirmation reflects Domtar’s reasonable operating performance despite price volatility in certain markets and continued strong credit metrics, which remain notably stronger compared to the current rating category’s range. The rating is supported by Domtar’s leadership position in the North American uncoated freesheet paper market and its low-cost operations, while the rating remains constrained by over 80% of sales being generated by the cyclical pulp and paper business and its exposure to various key inputs (e.g., fibre, chemicals, freight).

In the last 12 months (LTM) to September 2015, Domtar’s sales fell somewhat compared to F2014, reflecting some volatility in key markets in North America (over 80% of 2014 sales). While operating margins declined, cost reduction efforts mitigated the impact, as did the introduction of new products and the increasing proportion of Personal Care sales in the overall business, a faster-growing and higher-margin business segment.

DBRS anticipates that in the near term, Domtar’s business profile is likely to gradually strengthen as the transition to a greater proportion of Personal Care sales (absorbent core products, i.e., diapers, feminine hygiene, incontinence pads) in the overall mix continues. In the nine-month period to September 2015, the Personal Care segment accounted for 16% of sales and 18% of EBITDA. In 2013, these percentages were 10% and 12%, respectively. This trend represents a shift toward a higher-margin business with greater growth potential compared to Domtar’s traditional uncoated freesheet (UFS) office paper business, and is helping the Company to develop a more balanced product portfolio.

Domtar’s strategic plan includes acquisitions, especially in the Personal Care space. The Company had $128 million in cash on the balance sheet as at September 30, 2015; thus, a sizeable acquisition would require debt financing. Under such a scenario, the Company’s financial profile would be expected to weaken somewhat. That said, there remains significant cushion between current key credit metrics and the ranges consistent with a lower rating category. Thus, in the absence of a major debt-financed acquisition, Domtar’s key financial metrics are likely to remain supportive of the current rating, at least in the near term.

A major debt-financed acquisition (or acquisitions) as discussed above or a severe, sustained downturn in Domtar’s key North American end markets could lead to a negative rating action. Alternatively, a positive rating action would be considered if the Company continues to make material progress toward reducing its reliance on traditional and more volatile pulp and paper business lines, in favour of less volatile and higher margin consumer products.

Notes:
All figures are in U.S. 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.

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

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer and did not include participation by the issuer or any related third party.