DBRS Confirms Smurfit-Stone Corporation at B (high)

DBRS has today confirmed the Senior Unsecured Debt rating of Smurfit-Stone Container Corporation (Smurfit-Stone or the Company) at B (high). The trend is Stable.

The rating of Smurfit-Stone Container remains on track regardless of the fact that the corrugated packaging industry has experienced long periods of oversupply conditions in the past five years that have produced weak financial results. The Company’s heavy reliance on this sector results in a business risk that is greater than the forest product industry’s average.

Containerboard producers reduced supply to met demand in 2005 and 2006 and product prices have been on an upward trend since Q4 2005. Slow growth in packaging demand and containerboard/packaging industry capacity discipline should produce gradually increasing product prices. However, cost pressures, including high chemical and freight costs, and rising fibre prices are showing few signs of abating and are expected to offset some of the positive aspects of higher revenues.

The Company also faces the risk of (1) increased linerboard imports from China as more domestic capacity comes on stream in 2007 and 2008 (high freight rates are expected to constrain imports unless product prices rise substantially above current levels), and (2) pressure from major retailers to reduce packaging volumes. Despite the potential for a negative impact on earnings, the aforementioned risks are not expected to have a major impact on Company profitability in the near term.

A major restructuring plan to reduce costs is underway. The Company expects to achieve $525 million in annual cost savings by the end of 2008. Smurfit-Stone achieved $243 million in savings in 2006 and is targeting another $177 million in additional incremental cost reduction in 2007. Capex is expected to remain at high levels in 2007 and 2008 as the Company completes its restructuring and cost reduction program. Cash flow from operations is forecasted to be sufficient to fund capital expenditures in 2007 and 2008. However, free cash flow is only expected to be marginally positive in the next two years, preventing an improvement in the financial profile until the restructuring program is completed at the end of 2008. Smurfit-Stone has a long history of high leverage and this trend is expected to continue in the near term. As a result, the Company’s credit profile is not expected to change significantly over the next two years, remaining within the parameters associated with the above-noted rating.

The greatest risk facing the Company is a North American recession, particularly given its continuing high leverage. Smurfit-Stone would have limited financial flexibility to fund large free cash flow losses in the event of sharply lower earnings. However, DBRS does not expect this to occur over the near term, and the downside risk to the current rating is limited.

Note:
All figures are in U.S. dollars unless otherwise noted.