DBRS Upgrades West Fraser Timber Co. Ltd. to BBB (low), Trend Now Stable

DBRS has today upgraded the Issuer Rating and Unsecured Debentures rating of West Fraser Timber Co. Ltd. (West Fraser or the Company) to BBB (low), with a trend change to Stable from Positive. (The previous Secured Debentures rating has been replaced by the Unsecured Debentures rating, due to removal of security over existing debentures per terms of West Fraser’s credit agreement.) As a result of the current rating action, DBRS has also discontinued the recovery rating previously assigned to the Company’s senior debt. The upgrade reflects the sustainability of West Fraser’s credit metrics at the new rating level, driven by the sustained improvement of the U.S. housing industry since the trend was changed to Positive in November 2012. The Stable trend reflects DBRS’s view that the Company’s credit metrics are expected to remain solid in the investment-grade range for the foreseeable future. Furthermore, West Fraser’s above-average business profile, low-debt financial profile and its ability to generate free cash flow during times of weak market conditions also provide support to the BBB (low) rating.

Since DBRS placed West Fraser on Positive trend in November 2012, North American lumber market conditions have continued to strengthen, in line with the continued improvement in the U.S. housing market. As a result, West Fraser’s half-year 2013 operating results were very strong, largely driven by higher lumber prices. Notwithstanding the latest 10% June U.S. housing starts decline from the previous month (mainly due to a decrease in multi-family starts), single-family housing starts, which is the main driver for the lumber market, have been steadily improving. Moreover, despite the decline, the National Association of Home Builders/Wells Fargo sentiment index continued to rise, and is currently at its highest level since 2006. The strengthened lumber market conditions were reflected in strong SPF (spruce, pine, fir) and SYP (southern yellow pine) prices, which reached record-high levels near the end of Q1 2013. However, both prices experienced sharp declines in Q2 2013 as lumber supply outpaced lumber demand; despite the declines, both prices remained above the average levels seen in 2012.

Moreover, the declines have stopped at the end of Q2 2013 and both prices are rising again. Based on the positive trend of U.S. single-family housing starts and the housing market index, DBRS expects the U.S. housing market to continue its recovery going forward, reaching about one million units at end of 2013 from 780,000 units in 2012. We also expect the corresponding lumber market conditions to be favourable, driven by the rise in demand from the stronger housing market.

As a result, West Fraser’s 2013 full-year lumber and panel results are expected to be much stronger than last year. On the other hand, 2013 pulp results are expected to be comparable to 2012, with lower production volumes being offset by lower production costs and pulp prices remaining relatively stable. The expectation of stable pulp prices for the remainder of 2013 reflects DBRS’s view that the current excess global pulp supply will continue.

West Fraser’s business profile is above-average compared with industry peers. It is the largest lumber producer in North America, with strong exposure to western Canada and the southern United States, and is also one of the industry’s lowest-cost producers. The Company has a solid position in pulp, which provides a degree of business diversity, and has in the past stepped up its investment program to modernize its operating assets. West Fraser is well-positioned to benefit from the current improvement of the U.S. housing industry.

Moreover, over the past few years, West Fraser has been actively paying down debt with free cash flow and reducing risk in its financial profile. The ratio of gross debt-to-total capitalization has declined to about 17% in 2010 from 26% in 2007, and has since remained at this level.

In the medium to long term, the reduced availability of logs from the British Columbia interior and Alberta due to the mountain pine beetle infestation is expected to limit the supply of Canadian logs, and therefore have a positive effect on overall North American lumber prices during the recovery of U.S. housing market. However, it would also increase logging costs for West Fraser’s Canadian operations, which would translate into lower profit margins for the Canadian operations compared with the U.S. operations.

Despite having been downgraded into the high-yield rating category during one of the worst U.S. housing cycles, West Fraser demonstrated credit strength by its ability to generate free cash flow during that period. Moreover, lumber industry capacity has been adjusted to current market conditions and therefore impacts from an unexpected downturn of U.S. housing market would not have as much of an impact as in the 2007-2009 period. On top of that, the U.S. unemployment rate has been declining steadily since 2011, which bodes well for the recovery of the U.S. housing market. In conclusion, DBRS expects the U.S. housing market to continue its recovery and for the credit metrics of West Fraser to remain solid in the investment-grade range for the foreseeable future.

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 the Forest Products Industry (June 2013), which can be found on our website under Methodologies.