DBRS Confirms Norbord Issuer Rating at BB (low) and Downgrades Recovery Rating

DBRS has today confirmed the Issuer Rating of Norbord Inc. (Norbord or the Company) at BB (low), and the trend is Stable. The confirmation reflects the fact that the Company has performed as expected. Although the financial profile is weak, the current rating continues to be supported by Norbord’s solid business profile as a leading and low-cost producer of oriented strand board (OSB) in North America and the implied support from Brookfield Asset Management Inc. (BAM, rated A (low) by DBRS), Norbord’s majority owner. Moreover, the Company is well positioned to reap the benefits of the eventual recovery in the U.S. construction industry.

DBRS has downgraded the recovery rating of Norbord from RR2 to RR3 to reflect the expectation of lower recovery, solely due to a lower estimate of Norbord’s enterprise value and higher debt at default. DBRS has reduced the Company’s enterprise value, taking into consideration recent weak performances at Norbord and lingering weak industry conditions. With a revised recovery of RR3, the Secured Debentures and Senior Secured Notes (secured debts) will only be one notch higher than the Issuer Rating. The secured debts have been downgraded to BB from BB (high).

DBRS expects Norbord to report a moderate year-over-year decline in 2011 operating performance due to a continuing weak U.S. housing market and some one-off conditions that boosted product prices and results in 2010. As expected, residential construction activities in the U.S. remained subdued through the first nine months in 2011, and OSB prices came under pressure. In addition, higher input costs (fibre, resin and energy) further added to margin pressure. Norbord was near break-even on an EBIT basis for the first nine months in 2011, despite benefits from the margin improvement program (MIP) and better results from its European operations.

Weaker performance in 2011 has pushed the key credit metrics to below the current rating range. However, DBRS notes that the current rating is still appropriate for the following reasons:

(1) The Company has a solid business profile as a leader and a low-cost producer of OSB in North America. Recent progress made in the MIP to lower costs and improve productivity further solidifies its leading position. DBRS believes that the worst is over for the construction industry in this cycle, although the timing of an eventual upturn is uncertain. Moreover, the Company is well positioned to benefit when the industry recovers.

(2) Potential support from BAM, the Company’s majority owner, would help Norbord overcome financial stress through the current downturn. This is demonstrated by a recent commitment by BAM to provide a $120 million standby loan to Norbord to repay maturing debt in 2012, subject to certain conditions, if necessary.

(3) The Company has ample liquidity to weather the current weak conditions in the construction industry and has no refinancing risk even though the $240 million of Senior Debentures matures on July 1, 2012. The Company has amended its $270 million bank facility, allowing it to use $120 million for debt repayment. Together with the $120 million BAM commitment, the Company has sufficient cash to pay off the maturing debentures. This has mitigated the refinancing risk in case conditions in the capital markets are not favourable. Additionally, the Company has ample liquidity (cash on hand and unused bank facility totaling $317 million at the end of September 2011) to fund its operating needs.

The North American OSB market has stabilized in terms of supply and demand, which is illustrated by the stabilization of OSB prices after the 2010 price spike. OSB prices have been relatively stable for the last five quarters and are expected to remain relatively stable going forward as ongoing industry curtailments have helped bring supply in closer balance with demand. However, residential construction is expected to remain near current levels, and a meaningful upturn is not expected until late 2012 at the earliest. As a result, Norbord’s earnings in the next 12-month period are expected to remain near 2011 levels, while credit metrics are expected to slightly improve based on the assumptions that (1) capex will be maintained at conservative levels and (2) operating working capital will remain tightly managed.

Pursuant to the rating methodology for leveraged finance, DBRS has created a default scenario for Norbord in order to analyze when and under what circumstances a default could hypothetically occur and the potential recovery of the Company’s debt in the event of such a default. The scenario assumes that the Company is able to refinance the $240 million of Secured Debentures on similar terms in early 2012. Additionally, the scenario assumes that the U.S. economy fails to recover and falls into a recession in early 2013. This would lead to continued deterioration in the demand for building products. Under this scenario, the Company would exhaust its liquidity in late 2013. DBRS has determined Norbord’s estimated value at default using an EBITDA multiple valuation approach, consistent with a view that default would likely result in the restructuring and/or recapitalization of the assets with value as a going concern versus the sale of its individual assets. EBITDA multiples utilized are applied to cyclically normalized EBITDA at default as opposed to the actual low EBITDA values expected at the time of default, reflecting the forward-looking nature of the valuation. The valuation considers the issuer and the specific debt instruments, allocating value proceeds accordingly. Based on the default scenario above, the secured debts would have recovery estimated between 50% and 70%, which aligns with a recovery rating of RR3. Therefore, the instrument rating of the secured debts is BB, one notch higher than the Issuer Rating.

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

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