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 confirmations reflect continued production growth across the Company’s three business lines, a financial profile that remains strong for the current rating despite some market-related weakness and a strong business profile supported by low-cost operations.

In the last 12 months (LTM) ended March 2016, the Company’s operational performance in terms of output continued to grow. The growth was both organic and, in the Lumber segment, supported by acquisitions. The weaker Canadian dollar partially mitigated significant key U.S. dollar benchmark price declines, enabling sales to rise across all three divisions, year over year. EBITDA during the period fell dramatically (42%), reflecting lower margins across all business segments, particularly in Lumber. The overall EBITDA margin fell to 9% from 16%. Higher purchased log costs in British Columbia due to increased scarcity resulting from the pine beetle infestation continues to be a material driver of cost increases. Log costs for the U.S. operations also increased due to higher competition for logs associated with rising U.S. housing activity. Freight costs, denominated in U.S. dollars, also rose in Canadian dollar terms. Higher chip costs and rising power costs affected the Pulp & Paper segment, although natural gas prices came down somewhat, and West Fraser continues to mitigate power cost increases with its sales to the grid under its power purchase agreement.

The standstill period after the cessation of the North American Softwood Lumber Agreement (SLA) ends in October 2016. With American producers lobbying for a quota against Canadian lumber producers, the ongoing negotiations are likely to be drawn out over an extended period of time. At this stage, DBRS anticipates that in the interim, U.S. authorities are likely to apply some sort of duty to Canadian producers (especially those such as West Fraser using the Crown lands stumpage system) starting in 2017. While upon the conclusion of a new SLA, any excess duties paid would be returned to the Canadian producers (as was the case during the last SLA), this could take years, and there would be substantial uncertainty regarding the amount of funds that might be returned.

West Fraser’s business risk profile has not changed over the last 12 months. Despite the margin decline, the Company’s low-cost operations and high degree of pulp woodchip self-sufficiency continue to bolster its profitability, and this becomes particularly apparent during market downturns. The Company’s main challenge continues to be volatility in its key end product markets.

While the financial risk profile weakened again, the key metrics for LTM March 31, 2016, remain well above the current rating level. The Company continues to enjoy substantial cushion regarding its financial position compared to its rating. However, the substantial volatility associated with its product commodity markets indicate that when business risk considerations are taken into account, the current rating is appropriate. A particularly harsh and prolonged market downturn would need to occur for DBRS to consider a negative rating action.

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.